If you own a small business, a SEP IRA can be a very attractive offer. They are designed to be extremely simple. They require very little administration, and they make it as straightforward as possible to pump life into your retirement savings.
Even if you have little experience with retirement accounts, it’s as easy as filling out a few forms.
SEP IRA Rules
Just like any tax advantaged retirement account there are specific rules that govern SEP IRA accounts.
The most common question is whether a SEP is like a traditional IRA or a Roth in how the taxes are handled. There are no Roth options for a SEP so all money is invested pre-tax and then taxed as income when you withdraw it.
Just like your IRA or Roth, you cannot withdraw money from your SEP until you are 59 1/2 or if you choose to take equal distributions over a five year period prior to turning age 59 1/2.
Who can Open a SEP IRA
A SEP can only be opened by a business. Now if you read tax code that is more of a loose term than you might expect.
What is boils down to is that if you have any sort of 1099 income you can open a SEP and use a portion of that money to fund your account. This could be anyone including Uber drivers, free lancers, or someone with a full time business.
If you are an employee of a business and only receive W-2s for your income each year, the only way you can get a SEP IRA is if your employer offers one for you.
Who Qualifies for a SEP IRA account?
Any business owner qualifies to open a SEP account. Just have some sort of 1099 or business income and you can open a SEP.
For employees, the requirements to have a SEP IRA through your employer are simple. You have to be:
- older than 21 years old
- have worked for your employer in the three of the last five years
- be paid at least $600 a year
SEP IRA Contribution Limits for 2018
One attractive feature of SEP IRAs is their contribution limits. One important thing to take note of is the limits change every year. In 2018, you can contribute up to 25% of an employee’s compensation, up to $55,000. These limits are drastically higher than other IRA accounts, which makes them an attractive option for retirement accounts.
Depending on your age or the age of the employee, you might be eligible for catch-up contributions. These are special rules for older employees to help them boost their accounts as they get closer to retirement. With these catch-up contributions, you can put as much as $61,000 every year.
Finally, the SEP IRA contribution does not affect contributions to other IRA accounts. For example I can put $5,500 into my Roth IRA account OR my traditional IRA account. On top of that I can contribute up to 25% of my business income into a SEP.
The two are completely exclusive. Think of them as two completely separate buckets to put money in.
Changes to Rules and Limits over 5 Years
The contribution limits for SEP IRAs, and just about every other kind of retirement about can change every year. As the cost of living changes, the government will change how much you can put into the accounts to help set up a reasonable nest egg. SEP IRAs have seen quite a few changes to their rules and limits over the past several years.
2018 is the second straight year the contributions have risen. For anyone with a SEP IRA account or anyone who is looking to open an account, getting higher contribution limits can help boost your retirement accounts.
In 2016, the limits were not raised at all. There are several different factors the IRA looks at when deciding if they should change the limits at all. They will take a look at the cost of living and inflation rates. If inflation rates are low, there is a good chance they won’t touch the limits.
If you go back five years in time, all the way back to 2013, the contributions were slightly different. The limits in 2013 were 25% of the total salary, up to only $51,000. Through the past several years, the limit has slowly crept up to what it is today.
Creating SEP IRA for Employees
If you want to create a SEP IRA program for your employees, the first thing you’ll need to do is decide where the accounts are going to be held. There are dozens and dozens of banks and investment brokerages which offer these accounts. All of them have various fees, rates, and benefits you’ll need to consider when shopping around.
After you’ve chosen the financial institution, the next step is to complete all of the paperwork, which will include a written agreement to give all of the benefits to the eligible employees at your business. Aside from a few exclusions, like age or length of employment, you have to offer every employee the opportunity to participate in the IRA program.
After the paperwork is finished, you need to distribute the information to your employees. The institution should give you the pamphlets and papers which explains the SEP IRA. Make sure all of the employees fully understand the benefits of the IRA and the contribution limits.
Once you’ve given out the information, it’s time to open up an IRA for each employee. This requires some simple basic information:
- Date of Birth
- More details if necessary
One of the unique factors of a SEP IRA is if you have employees who are eligible to participate in the account, you have to contribute on their behalf. You have to contribute an equal percentage of their own compensation. For example, let’s say you are going to put 15% of your salary in your account, you’ll need to put 15 %of the employee’s compensation in their account.
SEP IRA Versus Traditional IRA
For the most part, SEP IRAs and traditional IRAs are similar, but there are a few fundamental differences. Obviously, the main difference is the contribution limits. With a traditional IRA, you can put up to $5,500 every year. If you’re over 50, then you can contribute up to $6,500. As you can see, the traditional IRA limits are much lower than SEP limits.Those contribution limits can make a huge impact on your retirement savings account.
Anyone can open a traditional IRA account, but there are a few more restrictions on who can open a SEP IRA. You have to be a business owner, or sole proprietor can open one of these accounts.
Places to Open a SEP IRA
When you’re looking around for a place to host your SEP IRA, there are several key factors you need to look at to ensure you’re getting the best plan for you and your employees.
If you want to be able to control all your investments then you should look at an online brokerage account. Online brokerage accounts have access to mutual funds, stocks, and all sorts of investing options, but cost much less in fees than a traditional broker.
Some of the most popular online brokerages include:
If you want to be able to invest without having to do much of the management yourself I would highly recommend Betterment. Betterment is a robo-advisor that allows you to answer a short questionnaire to understand your needs and risk tolerance and then does all the investing for you.
All you do is deposit money into the account and log in to see how things are going. It is similar to having a financial planner do your investing for you without all the high fees.
If you have employees, each employee will get a customized account to their preferences and Betterment will take the investing from there. For more information you can see my review of Betterment that details exactly how everything works on their platform.
Preparing for Retirement
Regardless of which type of retirement account you use, either SEP IRA, traditional IRA, ROTH IRA, or one of the other options, it’s vital you get started as soon as possible. The sooner you start contributing to the retirement account, the more potential the account has. A few short years can make a world difference in the world of investing.
In fact, even if you decide to open a SEP IRA, you can still open up an additional retirement account. You shouldn’t rely on only one account to fund your retirement. Most people will have more than one account, like having a ROTH IRA and a SEP IRA.
If you need any help deciding what kind of IRA program would be best, a financial advisor can walk you through the process, determine your financial goals, and help you make the most of those accounts.