A SEP-IRA (SEP stands for "simplified employee pension") is a retirement plan option open to the self-employed and to small-business owners. SEP-IRAs allow only employer contributions to the plan. As a type of IRA, a SEP-IRA gives small-business owners access to a wide variety of investments.
Benefits of a SEP-IRA for Self-Employed Individuals
A SEP-IRA has a number of benefits for the self-employed.
A SEP-IRA can be established and funded up to the tax filing date for your clients for the prior year, including any extensions. For those whose self-employed business is set up as a sole proprietorship and who file Schedule C as part of their personal tax return, these dates will coincide with the due dates for their individual return.
For clients whose business is set up as a separate entity, the key filing dates are those for their business tax returns, including extensions.
Contributions to a SEP-IRA are flexible. Your self-employed clients can skip contributions altogether for a given year or contribute any amount their income allows, up to the annual maximum.
SEP-IRAs are easy to establish, and the administrative requirements are fairly minimal. Each participant in the SEP-IRA has their own account, and unlike a plan like a 401(k), there are no testing requirements or similar administrative requirements.
SEP-IRA Eligibility Requirements
The IRS says, "Any employer, including self-employed individuals, can establish a SEP."
If your self-employed business has employees, the IRS says that employees who have met these requirements must be eligible to participate in the SEP-IRA:
- They are at least 21.
- They have worked for the business in at least three out of the past five years.
- They have received at least $750 in compensation for the past year or expect to receive at least that much in 2023.
An employer can use less restrictive eligibility requirements, but they cannot impose requirements more restrictive than these.
How a SEP-IRA Works for Self-Employed Individuals
Contributions to a SEP-IRA are made 100% with employer contributions — no employee contributions are allowed. This differs from other self-employed retirement plans like a solo 401(k) or a SIMPLE IRA that are funded with employee salary deferral contributions as well as employer contributions.
After opening a SEP-IRA account in their name, the self-employed individual is able to direct their own investments as they see fit. As with other types of IRA accounts, they can generally invest in any type of investment offered by the account custodian. This includes individual stocks and bonds, ETFs, mutual funds, cash accounts and a host of others. If they want to directly invest in gold, rental property or a number of other alternatives, they can consider opening a self-directed SEP-IRA.
SEP-IRA Contribution Limits
The contribution limit for a SEP-IRA is 25% of compensation. There is a dollar limit cap on this percentage. For the 2022 tax year, it is $61,000. For 2023, the dollar limit increases to $66,000. Unlike with a regular IRA or a workplace retirement plan like a 401(k), there are no additional catch-up contributions for those 50 or older.
For those who are self-employed and whose business is structured as a sole proprietorship, contributions may be limited to 20% of net Schedule C income.
Tax Advantages of SEP-IRAs for the Self-Employed
Contributions to a SEP-IRA are made by the self-employed individual's business. Whether they operate through a separate entity like an LLC or S corporation or as a sole proprietor filing a Schedule C as part of their personal tax return, these contributions are considered a business expense and serve to reduce their business income.
In the case where they are set up as a separate business entity, this will reduce the net income of the business, which passes through to their personal return. Overall, these contributions will reduce their personal income and the amount of taxes due. For those who are sole proprietors, the contributions work in a similar fashion. As a business expense, the contributions will reduce their Schedule C net business income, lowering the amount of business income reflected on their personal tax return. It is always best to consult with the client's tax professional in determining the full tax impact of a SEP-IRA.
Comparing SEP-IRAs to Other Self-Employed Retirement Plan Options
A SEP-IRA is one of several self-employed retirement plan options your clients can consider.
