Small Business Spotlight: Simplified Employee Pension (SEP) IRA

If you’re a small business owner, you’re part of the backbone of the economy. The Small Business Administration (SBA) estimated that 99.7% of all businesses in the United States are small businesses. You work hard every day and put in long hours to make your business successful. But are you taking time to make sure your retirement is on track as well?

Small business owners have a lot of choices when it comes to their retirement investments, including the traditional IRA, SIMPLE IRA, Solo 401(k), and profit-sharing plans. Each retirement plan has its pros and cons. But a Simplified Employee Pension IRA, also known as a SEP-IRA, is often overlooked. Yet, it’s quick to set up and administer—and is a retirement plan every small business owner should consider.

Designed with Small Businesses in Mind

A SEP-IRA is intended for self-employed individuals and small business owners with employees or even no employees. It has low setup costs and minimal paperwork and tax filing requirements. Also, annual SEP-IRA contribution limits are higher than they are for a traditional IRA, Roth IRA, or a workplace 401(k) if you have a full-time job.

SEP-IRA Contribution Limits

For 2022, business owners can contribute up to 25% of their self-employment/small business income, or $61,000—whichever is less—to a SEP-IRA. If you have employees, you also have to contribute to their SEP-IRAs at the same rate of salary you do for yourself. For example, take the following scenario:

As the business owner, if you contribute 10% of your salary to a SEP-IRA ($10,000), you would have to contribute 10% for each of your eligible employees—in this case, $17,500 in total, for all your employees. But remember, you can deduct all of your contributions on your federal income tax return.

Need help modeling contribution amounts or figuring out which of your employees might be eligible for your plan? Use our Contribution & Eligibility Calculator.

From both a small business owner and an employee perspective, SEP-IRA contributions are treated very favorably by the Internal Revenue Service (IRS). According to the IRS website: “You can deduct your contributions and your employees can exclude these contributions from their gross income.” In other words, you get a tax deduction for contributions that meet the IRS limits, and your employees do not have any extra tax filings because you gave them a contribution. They do, however, need to set up a SEP-IRA employee account in order to receive your contribution.

According to SEP-IRA rules, contributions are not subject to federal income tax withholding, Social Security, Medicare, and federal unemployment (FUTA) taxes.

Contributions to SEP-IRAs can be invested in the same types of securities as a Traditional IRA and are taxed only when funds are withdrawn.

Designed with Flexibility

As most small business owners know, profits and cash flow can vary from one year to the next, often due to macroeconomic forces that can’t be controlled. This is where the flexibility of a SEP-IRA can be invaluable. With a SEP-IRA, you set the percentage you contribute annually, and you can change it year to year if necessary. You can even skip a year—or multiple years—if you don’t have the money to contribute. You may even contribute in one year and never again.

A SEP-IRA can also be used by sole proprietors, independent contractors, or freelancers who are in essence small business owners themselves. You do not need employees to contribute to a SEP-IRA.

The flexibility extends to the SEP-IRA contribution deadline as well as the origination deadline. In fact, the rules offer small business owners one of the few retroactive tax deductions available. Small business owners have until the due date of their company’s tax return to open and fund a new SEP account—which for most businesses is April 15. However, if you file an extension for your business taxes, you may be able to open and fund your SEP-IRA as late as October 15 (or through your company’s tax extension date depending on whether you file taxes as a “C” Corporation, “S” Corporation, partnership, or sole proprietorship). For example, if you are a sole proprietor and want to open and/or fund a SEP-IRA for 2021 and you have a tax extension, you can do so as late as October 17, 2022.  

If you’re considering a SEP-IRA, TD Ameritrade can help you better understand the different types of retirement plans to see if it’s right for you. Check out our Plan Comparison Tool (Retirement Plan Selector) to learn which plans might work best based on your goals and needs.  

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.