By Basic Worth
A Simplified Employee Pension (SEP) IRA is a type of individual retirement account (IRA) designed for small business owners and self-employed individuals. SEP IRAs allow for contributions to be made on a tax-deferred basis, meaning that contributions are not taxed until they are withdrawn in retirement.
Here’s how a SEP IRA works:
- The employer establishes a SEP plan and sets up SEP IRAs for eligible employees, including themselves if self-employed.
- The employer can contribute up to 25% of each eligible employee’s compensation, up to a maximum of $58,000 for 2021. The contribution is tax-deductible for the employer and does not count as income for the employee.
- Employees cannot contribute to a SEP IRA, only the employer can make contributions on their behalf.
- Withdrawals from a SEP IRA are taxed as income and may be subject to a 10% penalty if taken before age 59 1/2.
SEP IRAs offer several benefits, including high contribution limits and tax-deferred growth. They are also relatively easy to set up and administer compared to other retirement plans. However, there are some drawbacks to consider, such as the inability for employees to contribute and the potential for penalties if money is withdrawn before age 59 1/2.
Why get a SEP IRA?
There are several reasons why a small business owner or self-employed individual may choose to establish a Simplified Employee Pension (SEP) IRA:
- High contribution limits: SEP IRAs allow for significant contributions, up to 25% of eligible employee compensation or $58,000 for 2021, whichever is less. This can help boost retirement savings and potentially lower taxable income.
- Tax-deferred growth: Like other retirement accounts, SEP IRAs offer tax-deferred growth, meaning that contributions and earnings are not taxed until they are withdrawn in retirement. This can help maximize the potential for growth and reduce the tax burden in retirement.
- Easy to establish and administer: SEP IRAs are relatively easy to set up and administer compared to other retirement plans, such as 401(k)s. Employers can establish a plan and open accounts for eligible employees without having to file annual reports or meet other complex requirements.
- Attract and retain employees: Offering a retirement plan can help attract and retain employees, particularly in a competitive job market. SEP IRAs are a cost-effective way for small businesses to offer a retirement benefit to their employees.
It’s important to carefully consider all of the factors before choosing a SEP IRA or any other retirement plan. A financial advisor can help you understand the options available to you and choose the best retirement plan for your individual needs and goals.
