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Top 6 Things Entrepreneurs Should Know About a SEP IRA Thumbnail

Top 6 Things Entrepreneurs Should Know About a SEP IRA

As a small business owner, you care about the future well-being of your employees. And just as you keep them safe in the workplace, you want to be sure you’re helping protect their future retirement as well. In doing so, it’s likely you’ve searched for effective avenues in helping employees (and yourself) contribute to their nest egg. If you're seeking alternative options to a formal profit-sharing plan or 401k, a SEP IRA (Simplified Employee Pension Individual Retirement Account) may be the answer.

With low administrative fees, flexibility and lower costs, here are five other facts employers (and self-employed persons) need to know about SEP IRAs.

1. SEP IRAs Differ From Regular and Roth IRAs

Traditional and Roth IRAs are opened by individuals, they are not operated through or sponsored by an employer. SEP IRAs, alternatively, are tied to your place of employment. A business owner, whether they have employees or are self-employed, sets up a SEP IRA account for employees and makes contributions to all accounts (including his or her own).

Setting up a SEP IRA can offer employers certain tax breaks and, like a traditional IRA, employees are not taxed on the contributions until funds are withdrawn.

2. Contribution Limits Are Higher

The deadline for making tax-deductible IRA contributions for a given tax year is usually April 15. All retirement accounts have a limit on how much you can put in for a given tax year. The IRS updates these limits each year. 

The SEP IRA, on the other hand, has a contribution limit with much higher dollar threshold (compared to traditional or Roth IRAs), or 25 percent of the employee’s income, whichever is lesser. There are no minimum contributions required.

The SEP IRA can be opened and funded after the tax year ends up through any tax filing extension. SEP IRAs provide a flexible way for employers to look at the end-of-year company financial state and make SEP IRA contributions accordingly. Just like other pension plans at larger companies, employees do not contribute to the SEP, only the employer is permitted to contribute.

3. SEP IRA Have Certain Eligibility Requirements

In order to be eligible to participate in an employer-sponsored SEP IRA, employees and business owners must:

  • Be 21 years of age or older
  • Have worked for the employer in the last three of the previous five years
  • Have earned at least $600 from the employer during the previous year

An employer may choose to be less restrictive in their eligibility requirements, however, they can not be more strict than the requirements listed above.

Also, be aware that if you are a business owner and make a contribution to your SEP IRA account, you must also make the same percentage contribution to your eligible employees’ accounts. In other words, you can't treat yourself better than employees when it comes to this type of retirement plan. 

4. You Can Exclude Certain Employees From SEP IRA Contributions

There are certain instances in which employees within your company may be excluded from your SEP IRA plan. According to the IRS, these include:

  • Those who are part of a union agreement and/or their retirement benefits are a result of collective bargaining.
  • Nonresident alien workers who receive no compensation from the employer.

Also note there's a distinction between someone who is an employee and a contractor. Only true employees fall in the criteria above. Be careful when making a determination if someone is a contractor or employee in the eyes of the government. If you're unsure, it may be a good idea to consult with an attorney who has experience with the regulations around these employment rules. 

Employees who do participate in an employer-sponsored SEP IRA are 100 percent vested in their SEP IRA accounts. Whatever the employer contributes immediately belongs to the employee. The funds can be transferred directly or rolled over into other IRAs.

"On the seventh day some of the people went out to gather, but they found none. And the Lord said to Moses, “How long will you refuse to keep my commandments and my laws? See! The Lord has given you the Sabbath; therefore on the sixth day he gives you bread for two days. Remain each of you in his place; let no one go out of his place on the seventh day.” Genesis 41:27-29 ESV

5. There Might Be A Tax Deduction in it for You

When your business contributes to a SEP-IRA for employees, you may be able to deduct that money as a business expense. The way you approach this potential tax benefit will depend on how your business is structured, but a qualified tax professional should be able to help you navigate the specifics. 

6. Solo Business Owners Qualify Too

If you don't have employees, don't worry because you can qualify for a SEP-IRA too. One of the benefits of a SEP is you can set it up when you're early in your business. If you hire employees down the road, a SEP can be updated to include employees as well in many cases. If you're an entrepreneur, don't forget to take care of yourself!

Bible Verses that Support Saving for Retirement

If you have a small family business or a limited number of employees, the SEP IRA has many of the features of a regular IRA, and the contributions are subtracted from your taxed income. The biggest advantage is the large amounts you can set aside for retirement.

Setting up a SEP IRA is a simple and inexpensive option to help you and your employees build a nest egg. You can open a SEP IRA at any bank, mutual fund company or brokerage firm with low (or no) annual account fees. If you are looking for an incentive to lure and retain good employees, a SEP IRA could be an attractive advantage.

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