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May 17, 2022

Is a SEP IRA Right For You?

by Paxton Dolan

In previous posts, we’ve talked about two of the more common individual retirement accounts (IRAs) – traditional IRAs and Roth IRAs. But there is another, lesser known, type of retirement account that could work well for you. It’s called the SEP IRA, and it’s what we’ll be taking a closer look at in this post.

SEP IRA piggy bank and man counting hundred dollar bills

SEP IRAs

Now, you may be asking yourself, what exactly is a SEP IRA? To start, SEP stands for “simplified employee pension”. These accounts are set up by employers to benefit both their employees and themselves. Self-employed individuals can also establish these. Tax-deductible contributions can then be made on behalf of eligible employees.

In order to participate in a SEP IRA plan, you must be at least 21 years old, have worked for your employer for at least three of the past five years, and have received at least $650 in compensation from your employer in the current year. Employers do have some ability to exclude certain types of employees from the SEP IRA.

These accounts are meant to provide retirement benefits to businesses that would not have them otherwise. Sole proprietors, partnerships, and corporations are all able to establish one of these plans.

So, how does a SEP IRA work? These are very similar to traditional IRAs in that the same transfer and rollover rules apply to both. They also both allow the same investment options and are treated the same for tax purposes. If an employer makes contributions to this account, then they receive the tax deduction. The amount contributed per year can change – and you can even decide not to contribute at all. While the employer is the one making the contributions, the individual account owners can make the investment decisions, which is a nice benefit for business owners.

The contribution amounts for these accounts are not as strict as those for traditional and Roth IRAs. At the time of this post, contributions must be under 25% of the employee’s compensation for the year, or $58,000 (whichever is lesser). The deadline to make contributions to a SEP is the tax filing deadline – April 15th.

SEP IRA Positives

If you qualify, there are a lot of benefits to opening a SEP IRA! For one thing, these are easy for business owners to set up, and they have low administrative costs. The flexibility to determine how much to contribute each year is also a nice feature.

Employees can have their wealth growing tax-deferred while they are working, while employers receive the tax deduction for all contributions made to these accounts. Not a bad deal!

Things to Keep in Mind 

If you are considering establishing a SEP IRA, there are a few things you will want to be aware of. You will be able to withdraw funds from this account at any age without being required to prove financial hardship. However, if you are under age 59 ½, your withdrawal will be subject to the same 10% penalty as withdrawals from other types of IRAs. There are a few exceptions to this rule, such as certain higher education expenses and health insurance premiums while unemployed.

Much like a traditional IRA, starting at age 72, you will be required to take a Required Minimum Distribution (RMD) from your account in order to pay back some of the money that has been growing tax-deferred. It is important that you do this, or you will be subject to a 50% penalty on the amount that was meant to be distributed.

Who Benefits Most from a SEP IRA?

Employers and employees who would not have retirement benefits otherwise can benefit immensely from these accounts. Self-employed individuals also benefit from the opportunity to set aside money for retirement.

SO, HOW DO YOU KNOW IF A SEP IRA IS RIGHT FOR YOU?

As always, if you are unsure of which accounts best serve your financial needs, we recommend seeking the assistance of a fiduciary financial advisor. Fiduciaries are legally obligated to work in your best interest and will help you to establish the accounts that will aid you in your unique goals. Feel free to contact our planners to discuss retirement planning!

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