Simplified Employee Pension (SEP) IRA: How it Works – NerdWallet

What is a SEP IRA?

A SEP IRA reads like a batch of letters, and spelling it out doesn ’ triiodothyronine necessarily aid : The first share stands for simplified employee pension ; the second for individual retirement explanation. translation : A SEP IRA is a basic individual retirement account, much like a traditional IRA. SEP IRAs are for business owners, and contributions are tax-deductible. Investments grow tax-deferred until retirement, when distributions are taxed as income.

SEP IRA rules: who is eligible?

generally, SEP IRAs are best for freelance people or small-business owners with few or no employees. here ‘s why : If you have employees whom the IRS considers eligible participants in your design, you must contribute on their behalf, and those contributions must be an equal percentage of compensation to your own .

  • eligible participants are employees who are 21 or older, have worked for you for at least three of the past five years and have a minimum of $ 600 from you in 2016-2020 or $ 650 in 2021. For model, if an employee worked for you in 2019, 2020 and 2021 and made $ 750, you would need to make a contribution for him or her for the 2022 design class .
  • If you want to stash away 15 % of your compensation for yourself, you must besides contribute 15 % of that employee ‘s compensation to his or her plan. Note that this is equitable an exemplar — the SEP IRA contribution limits for 2021 and 2022 are listed below .
  • Employees own and control their own accounts .
  • Because of that rule requiring peer contributions as a share of recompense, a SEP IRA is generally best for freelance people or small-business owners with few or no employees .

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NerdWallet rating  NerdWallet ‘s ratings are determined by our editorial team. The scoring formula for on-line brokers and robo-advisors takes into account over 15 factors, including report fees and minimums, investment choices, customer support and mobile app capabilities .

NerdWallet rating  NerdWallet ‘s ratings are determined by our column team. The scoring recipe for on-line brokers and robo-advisors takes into score over 15 factors, including account fees and minimums, investment choices, customer support and mobile app capabilities .

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SEP IRA contribution limits

A traditional IRA allows you to put away $ 6,000 each year ( that ‘s the annual maximum in both 2021 and 2022 ; it ‘s $ 7,000 if you ’ re 50 or older ). With a SEP IRA, you can stockpile closely 10 times that amount, or up to $ 58,000 in 2021 and $ 61,000 in 2022. however, SEP IRA annual contribution limits can not exceed the lesser of :

  • 25 % of recompense
  • $ 58,000 in 2021 and $ 61,000 in 2022 .

The first limit, 25 % of compensation, is besides the limit for how much you can contribute for each eligible employee. The sum of compensation you can use to calculate the 25 % limit is limited to $ 290,000 in 2021 and $ 305,000 in 2022. There ‘s no catch-up contribution at old age 50+ for SEP IRAs. » Are you on track for retirement ? Check our retirement calculator

How does a SEP IRA work? The pros and cons

PROS memorize
  • That high contribution terminus ad quem of up to $ 58,000 in 2021 and $ 61,000 in 2022 .
  • easy to set up and administer .
  • Can be combined with a traditional IRA or a Roth IRA .
  • Contributions are tax-deductible, including those made to employee accounts. You can deduct the lesser of your contributions or 25 % of compensation, subject to the compensation cap ( $ 290,000 in 2021 ; $ 305,000 in 2022. ). If you ’ re freelance, your deduction is 25 % of web self-employment income .
  • tractability : You do n’t have to commit to contributing every year .
  • No catch-up contribution for savers 50 or older .
  • No Roth interpretation, which means you ca n’t opt to pay taxes on contributions nowadays and take distributions tax-exempt in retirement, as you can by choosing a Roth IRA .
  • Required proportional contributions for each eligible employee if you contribute for yourself .
  • Like traditional IRAs and 401 ( k ) randomness, SEP IRAs require minimum distributions beginning at age 72 .
  • besides like a traditional IRA, distributions before age 59½ are taxed as income and subject to a 10 % punishment, unless the cause for the distribution satisfies one of the early withdrawal exceptions .

How do I open a SEP IRA?

It ‘s easy to open a SEP IRA bill on-line. The first step is to choose an account supplier. here are our top picks for best IRA history providers. then, the IRS outlines three steps for setting up your SEP IRA :

  1. Create a ball written agreement. You can do this with IRS Form 5305-SEP or through your account supplier .
  2. Give eligible employees information about the SEP IRA. You can give them a transcript of IRS Form 5305-SEP or get like information through your account provider .
  3. Set up branch SEP IRAs for each eligible employee with the explanation provider .

How do I invest my SEP IRA?

once you ’ ve opened the report, you can choose from the investments your account supplier offers. The selection typically includes stocks, bonds and reciprocal funds. ( It ‘s possible to open an IRA at a depository financial institution, but broadly you ‘ll be limited to investing in Certificates of Deposit, which normally offer a lower return than a diversified group of stocks and bonds. ) » Want more investing steering ? Read our post on how to invest your IRA. once the account is open and funded, you ’ ll want to invest it according to your age, planned retirement senesce and risk allowance. If you have a fairly strong stomach for market swings and a long time until retirement, your investment choice should sway toward stocks, specifically standard index funds, which track a segment of the market and hold a diverse mix of stocks within that section. The less clock you have until retirement — and the less solitaire you have for a market downturn — the more you ’ ll want to allocate toward bonds and adhesiveness funds. You can besides buy index funds for bonds. » Thinking about the future of your business ? Learn about sequence planning.

Can I have a SEP IRA and a Roth IRA?

You can combine a SEP IRA with a traditional or Roth IRA. If you ’ re an employee who is covered by a SEP IRA, employer contributions don ’ deoxythymidine monophosphate reduce the amount you can contribute to an IRA for yourself, but the come of your traditional IRA contribution that you can deduct may be reduced at certain higher income levels, ascribable to the combination of both plans. ( For more on that, see our mail on IRA contribution limits. )

Can I Contribute to Both a SEP IRA and Traditional IRA?

The government places no restrictions on contributing to both a SEP IRA and a traditional IRA in the like class. besides note you do not need to reduce your SEP IRA contribution to besides contribute to a traditional IRA. however, there are income limits to deducting contributions to a traditional IRA. Those with workplace retirement plans can lone take the full moon discount on a traditional IRA if their income is less than $ 64,000 ( $ 103,000 if married and filing jointly ).

If you exceed the income limits and are n’t eligible for a traditional IRA deduction, you could roll the funds from your traditional IRA into a Roth IRA using the back door Roth method acting. You can read our back door Roth article to learn more about how this works. By rolling over your funds into a Roth, you can enjoy tax-exempt distributions assuming you wait until your full retirement old age. The catch is that the government requires all rollovers from traditional to Roth IRAs be done on a pro-rata basis. This means that if you have an account with a $ 56,000 SEP IRA contribution and a $ 6,000 nondeductible traditional IRA contribution, you can not choose to merely rollover the $ 6,000. If you rolled over $ 6,000 ( 9.7 % of all of the $ 62,000 sum ), the government would treat that like you were rolling over $ 5,418 ( or 9.7 % ) of the SEP and $ 582 ( besides 9.7 % ) of the non-deductible traditional IRA, which is not what you intended at all. unfortunately, you don ’ t have the option of designating which dollars are getting rolled over. The entirely way to rollover the full non-deductible total into a Roth IRA would be to rollover all of your traditional assets ( this includes the full respect of your SEP IRA and other traditional IRA accounts )

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