January 3, 2022
It’s a Simplified Employee Pension Individual Retirement Account. Super clear, right? (We’re kidding.) A SEP IRA is a retirement account that offers tax advantages for business owners and those that are self-employed. And with “simplified” in the name, SEP IRAs are actually straightforward. They work much like traditional IRAs where the money you contribute grows tax-deferred until retirement. Contributions are also tax deductible, up to a certain amount.
SEPs can be attractive options for small business owners because they can be easy to set up and maintain. It’s up to the business owner to set up the SEP and decide when and how much they’ll contribute for their employees. However, employees own and control their accounts, including any investment decisions.
While technically any employer can open a SEP, they are generally recommended for business owners with few or no employees. The reason? If you’re a business owner offering a SEP IRA, you contribute on behalf of your employees, and the IRS requires that you contribute equally to all accounts. So for instance, if you want to contribute 20% of your own salary toward a SEP, you also have to contribute 20% of each eligible employee’s salary.
If you’re a small business owner, you must include employees in the SEP plan if they:
You may also choose less restrictive requirements for your plan (e.g., 18 years or older, three months of service).
The first step is to choose an account provider for your SEP IRA. There are a number of financial institutions to choose from, so do some research to find one that works for you. Once you’ve chosen where to open your account, the IRS requires the following:
These are the basic steps, but the IRS website lists the information required to inform your employees, along with more detailed requirements.
This is where the SEP IRA shines in comparison to a traditional or Roth IRA, which only allows you to contribute up to $6,000 in 2021 and 2022. With a SEP IRA, employers can contribute up to $58,000 in 2021 ($61,000 in 2022) or 25% of an employee’s compensation, whichever is less. Just remember that business owners have to contribute equal percentages to each employee’s account.
The one drawback is that SEP IRAs do not allow “catch-up” contributions. Typically, catch-up contributions allow you to contribute more money once you turn 50 (an additional $1,000 for Roth and traditional IRAs in 2021 and 2022) since you’re likely closer to retirement.
Generally, yes. This can get a little confusing though because a SEP IRA is technically just an individual retirement account that holds contributions under a SEP plan.
Here’s the deal: Even though your employer must contribute to your SEP IRA, you may also be able to contribute. Alternatively, you could open up a separate Roth or traditional IRA and contribute your own money that way. Just keep in mind that whatever individual contributions you make cannot exceed the total contribution limit for IRAs ($6,000 in 2021 and 2022).
Still confused? Let’s look at an example.
Say Sophia is the owner and sole employee of Company A, which offers a SEP IRA. Under that plan, Company A regularly contributes to Sophia’s SEP IRA – they even contribute the $58,000 maximum allowed for 2021. Remember, this is really all just Sophia’s money since it’s her company, but it’s an important distinction that it’s the business making the contributions.
Sophia also decides to contribute $3,000 to her SEP IRA this year. On top of that, she opens a Roth IRA. At this point, Sophia can only contribute $3,000 to her Roth IRA, bringing her total individual contributions up to the $6,000 maximum.
(And go Sophia for being a savvy business owner and maximizing her retirement savings!)
Here are some other things to keep in mind if you’re considering a SEP IRA:
Given the high contribution limits, a SEP IRA may be a great option if you’re a one-person shop. SEP IRAs are easy to set up and administer, which is probably music to your ears if you run your own business. They also have low administrative costs and allow you to contribute on your own terms each year.
If you’re not sure that a SEP is right for you, there are other retirement plans available for individuals and small business owners.
This article is for informational purposes only and is not a substitute for individualized professional advice. Individuals should consult their own tax advisor for matters specific to their own taxes and nothing communicated to you herein should be considered tax advice. This article was prepared by and approved by Marcus by Goldman Sachs, but does not reflect the institutional opinions of Goldman Sachs Bank USA, Goldman Sachs Group, Inc. or any of their affiliates, subsidiaries or division. Goldman Sachs Bank USA does not provide any financial, economic, legal, accounting, tax or other recommendation in this article. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice. Information contained in this article does not constitute the provision of investment advice by Goldman Sachs Bank USA or any its affiliates. Neither Goldman Sachs Bank USA nor any of its affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of the statements or any information contained in this document and any liability therefore is expressly disclaimed.