What is a SEP IRA? Designed with small businesses in mind, the SEP IRA may be ideal for small business owners and self employed individuals. From SEP IRA rules to contributions, TD Ameritrade can help you understand this retirement plan.
If you’re a small business owner, you’re part of the backbone of the economy. The Small Business Administration (SBA) estimates that 99.7% of all businesses in the U.S. 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 a retirement plan every small business owner should consider.
A SEP IRA is intended for self-employed individuals and small business owners with 100 or fewer employees—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 do have a full-time job.
For 2018, you can contribute up to 25% of your self-employment/small business income, or $55,000—whichever is less—to a SEP IRA. If you have employees, you also have to contribute to their SEP IRA accounts 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 employees—in this case, $17,500 in total, for all your employees. But remember, you can deduct all of your contributions.
From both a small business owner and an employee perspective, these 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 accounts can be invested in the same types of securities as a traditional IRA and are taxed only when funds are distributed.
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, you set the percentage you contribute annually, and you can change it from year to year if necessary. You can even skip a year—or multiple years—if you don’t have the money to contribute.
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.
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 (or April 17 this year). 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.
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.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
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