SEP IRA

A simplified employee pension (SEP) is an individual retirement account (IRA) that can be established by an employer or a self-employed person. An employer can deduct contributions made to a SEP IRA and makes discretionary contributions to each eligible employee’s plan.

The SEP IRA may be the best retirement plan for many self-employed workers due to its higher flexibility.

What is SEP IRA?

A SEP IRA, or Simplified Employee Pension Individual Retirement Account, is similar to an IRA but has a few added benefits that make it especially appealing to those who do not have access to an employer-sponsored plan.

A SEP IRA is a tax-advantaged retirement plan for self-employed individuals, business owners, employees, or freelancers. Because SEP IRA contributions are considered employer contributions, they are made by the company to the employee (who might be you).

The SEP-IRA is designed to be simple, especially if you own your own business and do not employ anyone.

How Does SEP IRA Work?

A SEP IRA is appealing to many business owners since it does not have much of the start-up spending associated with most conventional employer-sponsored retirement plans. Many firms also set up a SEP IRA to allow their employees to contribute more to their own retirement than the traditional IRA allows.

Small businesses choose SEP IRAs due to the eligibility requirements for contributors, which include a minimum age of 21, at least three years of employment, and a minimum compensation of $650 for 2022 ($750 for 2023). Furthermore, a SEP IRA allows employers to skip contributions during years when business is slow.

SEP IRAs are taxed in the same way as traditional IRAs and offer the same investment opportunities. SEP IRAs have the same transfer and rollover rules as traditional IRAs. When an employer contributes to SEP IRA accounts, the amount contributed is tax-deductible.

The company is not bound by yearly contribution requirements. The decisions about whether to contribute and how much to give might change from year to year.

Making investment decisions is not the employer’s responsibility. Rather, the IRA trustee chooses which investments are eligible, and individual employee account owners make specific investment decisions.

The trustee also deposits contributions, provides annual statements, and files all relevant documentation with the IRS.

SEP IRA Contribution limits in 2023

In 2023, you can contribute up to $6,500 to a traditional IRA. You can contribute an additional $1,000 if you are 50 or older. With a SEP IRA, you can save nearly ten times as much, or $66,000 in 2023. SEP IRA yearly contribution limits, on the other hand, cannot exceed the lesser of:

• 25% of compensation.
• $66,000 in 2023.

The first limitation, 25% of compensation, also applies to the amount you may contribute for each eligible employee. In 2023, the amount of compensation that can be used to compute the 25% limit is limited to $330,000.

They do not allow for catch-up contributions after the age of 50.

SEP IRA Rules: Who is eligible?

SEP IRAs are best suited for self-employed workers & small businesses. Here’s why: If you have employees who the IRS considers to be eligible participants in your plan, you must contribute on their behalf, and those contributions must be an equal percentage of your salary to your own.

• Employees who are 21 or older, have worked for you for at least three of the last five years, and have earned a minimum of $750 in 2023 are eligible. For example, if an employee earned $850 in 2019, 2020, and 2021, you must make a payment for them in the 2023 plan year.
• If you want to save 15% of your salary for yourself, you must also contribute 15% of that employee’s salary to their retirement plan. Please keep in mind that this is only an example; SEP IRAs are subject to the contribution limits indicated above.
• Employees are in charge of and own their own accounts.

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SEP IRA Pros & Cons

A simplified employee pension is a popular retirement plan because it provides numerous benefits, but it is not suitable for everyone.

Pros

• You can save for retirement: As a self-employed individual, your options for tax-advantaged retirement savings may be limited. However, the SEP IRA can be a helpful solution.
• Tax-deferred or tax-free: When deciding how to contribute, you have two options: traditional (pre-tax) or Roth (after-tax).
• Easy to set up: If you’re interested in SEP IRAs, a broker can assist you through a straightforward process.
• Make bigger contributions: You can contribute more to a self-employed 401(k) than to traditional and Roth IRAs, and also more than what you can contribute to a 401(k) offered by a regular employer. However, a solo 401(k) might allow you to save even more.
• Flexibility: It is not mandatory to make contributions every year, whether it be for yourself or your employees.

Cons

• Employees must be handled in the same manner as you: As the employer, you must contribute the same percentage of the employee’s contribution to their SEP account as you do to your own. Employees are not able to make their own contributions to the plan.
• No catch-up contributions: For individuals aged 50 and above, catch-up contributions are not available in SEP IRAs unlike in IRAs and 401(k)s. Nevertheless, the increased contribution limits of a SEP IRA could potentially outweigh this drawback.

Why Are Investors Diversifying Their Portfolio?

The financial system would be in great peril if one or more big banks fail.

“When we get to a downturn, banks won’t have the cushion to absorb the losses. Without a cushion, we will have 2008 and 2009 again.”

Student debt, which has been on a steep rise for years, could figure greatly in the next credit downturn.

“There are parallels to 2008: There are massive amounts of unaffordable loans being made to people who can’t pay them”

The US national debt has spiked $1 trillion in less than 6 months!

“If we keep throwing gas on flames with deficit spending, I worry about how severe the next [economic] downturn is going to be–and whether we have enough bullets left [to fight it],”

Total household debt rose to an all-time high of $13.67 trillion at year-end 2019.

“Any type of secured lending backed by an asset that is overvalued should be a concern… that is what happened with housing.”

How You can set up a SEP IRA?

A SEP IRA is easy to set up. Begin by completing and submitting IRS Form 5305-SEP. Rather than sending the form to the IRS on your own, you can have a broker sign up for you and deliver the form.

Compare SEP IRA custodians before making a decision. Examine the minimum investments, costs, and investment options available. If you decide to add staff, find out how they may access their accounts as well.

How Can You invest in a SEP IRA?

Your age, the age at which you want to retire, and your risk tolerance determine how aggressively you invest and the types of assets you purchase. When selecting investments for your portfolio, keep your own future needs in mind.

In general, asset allocation models suggest that you weight your retirement portfolio towards stocks when you are young and far from retirement. Many experts recommend adjusting your portfolio to incorporate more bonds as you approach retirement to reduce risk and increase income.

What’s the reason? Stocks have generally produced higher long-term returns than fixed-income investments, but they are more volatile in the short term.

Your account provider should offer a diverse selection of stocks, bonds, and mutual funds. Each of your employees should have their own accounts with the provider, allowing them to pick their own assets and asset allocation.

SEP IRA vs. 401(k) vs. Roth IRA

The SEP IRA is a popular retirement plan, and people who have the choice of this plan may also consider a 401(k) or a Roth IRA account. Here are some key differences:

• A SEP IRA is only available if your company provides it, and in some situations, your employer maybe you. If you’re a single freelancer, you can save up to 25% of your company’s earnings in your account tax-free, up to a maximum of $66,000 each year. The distribution criteria of the account are similar to those of a traditional IRA or Roth IRA, depending on the type of plan you’ve chosen.

• A 401(k) plan is an employer-sponsored retirement plan that allows you to save money tax-deferred or tax-free. Employees can save up to $22,500 (in 2023), and employers can contribute matching funds. The account is available in two varieties: traditional (pretax) 401(k) and Roth 401(k). One-person firms can save even more by opening a solo 401(k).
• Anyone with earned income (or spouses of those with earned income) can contribute to a Roth IRA. When making contributions, after-tax dollars are used, and the money is able to grow without being taxed until it is withdrawn. Contributions are limited to $6,500 annually, starting in 2023.

However,

The good news is that you can contribute to all of these plans. However, your combined maximum contribution to the SEP IRA and the 401(k) is $66,000, which includes both company and employee contributions.

You can max out your employee contribution in your day job’s 401(k), take advantage of an employer match, and then continue to contribute to your SEP IRA until you reach the annual maximum.

And, regardless of how much you contribute to a 401(k) or a SEP IRA, you can still contribute to a Roth IRA (or a standard IRA), up to the annual maximum.

Summary

A SEP IRA can be an ideal choice if you are self-employed and want to contribute to a tax-advantaged retirement plan. It allows you to contribute a significant amount each year and have your money grow tax-deferred or even tax-free. A SEP IRA is especially beneficial if you don’t have any other employees and don’t intend to hire any in the future.