Small Business Retirement: Debunking Some Common SEP-IRA Myths

Small business owners sometimes use Simplified Employee Pension (SEP) IRAs to contribute money to their employees’ retirement or even to their own.

But SEP-IRAs aren’t just for corporations. If you’re a freelancer, an independent contractor, a part-time business owner, or someone who earns income from side jobs, you may also be able to contribute to a SEP-IRA, and many of the rules for investing, distribution, and rollover are the same as for traditional IRAs.

A number of myths have sprung up around SEP-IRAs, which might create confusion. So let’s debunk some of those myths.

SEP-IRAs: Getting Started

One myth is that a SEP-IRA is hard to set up, but that’s not necessarily the case.

Setting up a SEP-IRA is as straightforward as answering a few questions, mostly about any employees you want to cover in your new SEP-IRA plan. If you don’t have any employees, then you will only be making contributions for yourself.

If you do have employees, then merely inform them about the plan and ask them to set up their own personal SEP-IRAs—just like you did. You’ll make the contributions into those accounts. 

If you have employees for your business, you can limit your contributions to those employees who are at least 21 years old, have worked three out of the five previous years for you, and earned $650 in the current year. For part-timers, just one hour counts as a year’s service.

TD Ameritrade offers an online process that can walk you through the steps to open an account, or you can fill out an application by hand and mail it in. The SEP-IRA application is the same as the IRA application. Plus business owners need to complete one additional form. Still dubious? Check out the IRS Form 5305-SEP now. It’s only one page. This form debunks another myth about SEP-IRA plans—that you need to approach a CPA or tax advisor to set them up. You don’t. It might be a good idea, and you may choose to do so, but it’s not required. 

Small Business Retirement That Fits Various Income Profiles

Another myth that stops some people from opening a SEP-IRA is the belief that they don’t have enough income to contribute. The beauty of the SEP-IRA, though, is its flexibility. You can change the percentage you contribute every year. You can skip years when you don’t have the money. You could even contribute once and never contribute again.

Note that a one-year contribution can be 25% of one’s income up to $58,000 for the 2021 tax year. That increases to $61,000 for 2022.

Need help modeling contributions for yourself or your employees? Try our new TD Ameritrade tool: Small Business Retirement Contribution & Eligibility Calculator. This handy tool may also be helpful as you determine which of your employees should be covered in your plan.

Have a Plan at Your Day Job? No Problem

Some think you can’t have a SEP-IRA for your side business if you already have a 401(k) from your full-time job. That’s another misconception.

In fact, if either the 401(k) limits or your day job’s salary have been limiting your retirement savings, SEP-IRAs allow you to make a contribution for yourself based on your side business income. SEP-IRA contributions for a side business won’t affect what you can contribute to your 401(k) as long as you don’t also own the business that offers the 401(k). And while most of us could use more tax deductions and retirement savings, this might not be beneficial for your personal situation, so you should check with your tax advisor to make sure.

Like Profit Sharing

All the money contributed to the SEP-IRA comes from the employer, not the employee. In that regard, the SEP-IRA contribution process is similar to that of a profit-sharing plan.

There’s no limit on the number of employees who are eligible, so it works for small or large companies. (Although larger companies might want to look at a 401(k) or profit-sharing plan in case they are a better fit for the company’s goals.) And try our new Plan Selector Tool to compare different types of business retirement plans to see which plan might best meet your goals and needs.

If you open the SEP-IRA at TD Ameritrade, you’ll have a wide range of available investments, much as you would have with a traditional or Roth IRA.

Tax Benefit

Another benefit of the SEP-IRA is that contributions may be considered a business expense that could reduce the net profit of a company, potentially easing the tax burden. Contributions that meet IRS regulations are generally tax deductible to your business whether you are a sole proprietor, partnership, LLC, S Corporation, or C Corporation. Make sure not to exceed the maximum contribution limits for the year you make your contribution for and make appropriate contributions for any eligible employees. And let your tax advisor know if you plan to make contributions, so you can plan accordingly.

Still have not filed your 2021 taxes yet? You may still open, contribute to, and get a tax deduction for 2021, assuming you have a 2021 tax extension. You have until your tax filing deadline, including extensions, to open a new SEP-IRA or contribute to an existing one. If you’re a calendar year filer (if you file a Schedule C or K-1 Form, for example), the deadline is October 17, 2022 for setting up and contributing to a SEP-IRA.

Review our SEP-IRA Guide for more on rules, benefits, and limits.