Ways Your Small Business Can Benefit by Choosing a SEP IRA

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SEP IRA retirement plan lets business owners make pre-tax contributions for themselves and eligible employees. Here’s how your business can benefit

Choosing a retirement plan

As a small business owner, you want to choose the right type of retirement plan for your business , while also making sure it’s the right choice for your employees. While the process of selecting a retirement plan can be confusing or expensive, consider if a SEP IRA meets your needs.

SEP IRA (Simplified Employee Pension) is a retirement plan based on an individual retirement account (IRA) into which business owners can make pre-tax contributions for both themselves and their eligible employees.

Most employers are eligible to establish SEP plans, and are most common among sole-proprietors. SEP IRAs are typically easy to establish, require little tax paperwork, low administrative cost, no initial setup, and no annual maintenance fees. Here’s a few ways your small business could benefit from SEP IRAs.

High yearly maximum contribution limit

SEP IRA plans have a high yearly maximum contribution limit. You can usually contribute more to the SEP IRA than a traditional IRA or Roth IRA depending on income limits. It’s best to consult with a qualified tax advisor before making any contributions. Check out this breakdown of Retirement Plan Contribution Limits for a basic overview of contribution limits.

Tax Year 2021 2020 2019
IRA Contribution Limit - 219(b)(5)(A) - Under Age 50 6,000 6,000 6,000
IRA Catch-Up Contribution Limit - 219(b)(5)(B) - Age 50 or Over 7,000 7,000 7,000
SIMPLE IRA Maximum Contributions - 408(p)(2)(E) - Under Age 50 13,500 13,500 13,000
SIMPLE IRA Maximum Catch-Up Contribution - 414(v)(2)(B)(ii) Age 50 or Over 16,500 16,500 16,000
Coverdell ESA Contribution Limit * 2,000 2,000 2,000
Employer Defined Contribution Limit - 415(c)(1)(A) 58,000 57,000 56,000
Elective Deferral Limit - 402(g)(1) 19,500 19,500 19,000
Elective Deferral Catch-Up Limit - 414(v)(2)(B)(i) 26,000 26,000 25,000
Annual Compensation Cap - 401(a)(17)/404(I) 290,000 285,000 280,000
SEP Minimum Compensation - 408(k)(2)(C) 650 600 600
SEP Maximum Compensation - 408(k)(3)(C)6. 290,000 285,000 280,000
457 Elective Deferrals - 457(e)(15) 19,500 19,500 19,000
Defined Benefit Limit - 415(b)(1)(A) 230,000 230,000 225,000
Highly Compensated Employee (HCE) - 414(q)(1)(B) 130,000 130,000 125,000
Key Employee - 416(i)(1)(A)(i) 185,000 185,000 180,000
Taxable Wage Base 142,800 137,700 132,900

Retirement Plan Contribution Limits 2021.pdf

Tax-deferred growth

Account earnings can grow tax-deferred until withdrawn. Similar to a traditional IRA or 401(k), contributions to a SEP IRA are not taxed in the year contributed. Because of this, the money can compound tax-deferred for a longer amount of time.

Contributions made by the employer are tax-deductible

The contributions you make within the limits are deductible on your business’s tax return. You can reduce your taxes on the contributions you make to your employees’ SEP IRA accounts since they are tax-deductible.

Flexible funding

With a SEP IRA, you are not required to make yearly contributions. Contributions can vary from year to year, or forego if needed. This can give you flexibility to contribute more when business is stronger, and pull back if you need to conserve.

Employee incentive

The SEP IRA plan is designed to allow you to make discretionary contributions to an employee’s IRA. Every participant has immediate and complete ownership of the money contributed by you. Employees are responsible for choosing his or her investments inside the account, and you don’t need to set up a schedule for vesting or track service requirements.

For your employees, SEP IRAs can have many benefits.

As the employer, you must have a SEP Plan established in order for your employees to participate. This plan you establish may require employees to meet any or all of these requirements before receiving employer contributions.

Here’s some information about participant and employee participation.

  1. Age requirement –

    you may require employees to attain age 21 prior to participating.
  2. Service –

    you may require an employee to work three out of the immediately preceding five years (for any period of time, however short)
  3. Compensation –

    employees earning less than $600 in compensation may be excluded.
  4. Class of Employees –

    employees covered under a collective bargaining agreement and non-resident aliens with no U.S. income from the employer may be excluded.

Some of the benefits for employees of a SEP IRA plan include:

  • Tax-Deferred Earnings –

    Earnings generated on contributions to a SEP IRA are tax-deferred. The earnings are not reported to the IRA and account owners do not include earnings in the account on their tax return.
  • Tax Deduction –

    The IRS encourages account owners to make an IRA contribution by offering a tax deduction to certain individuals. The ability to qualify for a tax deduction depends on your filing status, Modified Adjusted Gross Income (MAGI) and if they participate in a retirement plan at work.
  • Tax Credit –

    Some IRA holders may qualify for a tax credit. Participants should consult with an experienced tax adviser for further information.

As always, we’re here to help you. To learn more about the SEP IRA solution and see if it’s a fit for your business, contact us!

Sources:

LPL Financial

How Small Business Owners Can Benefit From SEP IRA, SD Retirement Plans

Features and Benefits of Sep IRAs and Roth IRAs, Investopedia

SEP IRA withdrawals before age 59 ½ are subject to a 10% federal penalty tax (certain exceptions may apply). Ordinary income tax will be owed on any taxable distributions.