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Is a SEP-IRA the Right Choice for Your Retirement Savings?

by
Cris Villarreal
on
11/4/2015
Is a SEP-IRA the Right Choice for Your Retirement Savings?

If you're self-employed or own a small business, you don't have the luxury of having an employer-funded retirement fund in place. Instead, you're left with the responsibility of setting up your own retirement fund and, if you have employees, figuring out which retirement offering is best for both your and their needs can be a challenge. After all, you have many options to choose from, ranging from Simple IRAs and Keogh Plans to 401(k)s and everything in between.

One option that you may not have yet considered, however, is the Simplified Employee Pension Plan (SEP). Although a SEP functions much like a self-employed retirement (Keogh) plan, the funds are held in an IRA account under the full control of the participant, making it an attractive option for self-employed and small business owners alike. Because an IRA is used to hold the funds, these arrangements are sometimes referred to as a SEP-IRA.

What Are the Features of a SEP?

A SEP is a retirement plan that allows self-employed individuals to make tax-deductible retirement contributions for themselves and their employees. The contributions made by the employer on behalf of the employees are excluded from the employees’ wages and are not subject to withholding for income tax or FICA.

Possible Advantages and Drawbacks

The employer can select the percentage rate of compensation to be contributed, but the maximum annual contribution for each employee to a SEP plan is the lesser of “25% of compensation” (20% of net profit after deducting the SEP contribution for the self-employed proprietor’s contribution) or $53,000 (this amount is subject to inflation-adjustment annually). The employer can decide each year whether or not to make a contribution and at what percentage rate, not to exceed the maximums noted above, which is a great benefit for start-ups and other small businesses with unpredictable year-to-year income that may be uncomfortable with committing to long-term contribution matches required with other types of retirement plans.

With a SEP, an employer who elects to make a SEP contribution for the year must contribute to a retirement account established for each employee who: Is at least 21 years of age,

  • Has worked for the employer in at least three of the prior five calendar years, and
  • Has compensation for the year of at least $600.

The only exceptions to these requirements are employees covered under a collective bargaining agreement.

Since the funds are deposited into IRA accounts under the control of the employees, they have free-reign to determine how they want to allocate and invest their SEP funds, taking a lot of the guess work and responsibility off the shoulders of the employer. When compared to other types of retirement plans, SEPs are easier and less costly to administer and require less paperwork and tax form filings.

An advantage to a SEP is it can be established after the close of the tax year and contributions can be made up to the extended due date for filing the tax return. So if after all the accounting is complete and your tentative tax determined, you can then decide whether to establish a SEP or make contributions to an existing one.

Unlike a traditional IRA account, contributions are allowed after the account owner is age 70½, even though that individual must begin required minimum distributions from the SEP once age 70½ is reached.

Distributions from a SEP account are always taxable, and if withdrawn before age 59½ the distributions are also subject to a 10% early withdrawal penalty.

How to Set Up a SEP

If, after considering all your options for a retirement plan, you decide a SEP is right for you, you can open a SEP account with generally any financial institution. The IRS also provides a model SEP that you can adopt by using IRS Form 5305-SEP. Complete and retain the form for your records; do not file it with the IRS. However, it may be more prudent to adopt a plan offered by the financial institution of your choice to ensure that all plan requirements are met.

When deciding where to open your SEP you'll want to be aware of the fees associated with your account. These can vary greatly depending on how the funds are invested, how much you invest, and how your account is being managed.

Overall, a SEP can be an excellent option for self-employed individuals looking to start a retirement fund. Looking for more advice on which type of retirement plan is best for you and your business? Speak with an experienced professional today. 

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Cris Villarreal

Cris Villarreal

Cris Villarreal PLLC is a Harlingen,TX CPA specializing in quality, personalized tax and accounting services. The firm provides a full range of services from basic tax management and accounting services to more in-depth services such as financial statements, and financial planning. Our mission is to help clients maintain financial viability in the present, while taking a proactive approach to achieve future goals. Services offered include: Tax Return Preparation Strategic Tax Planning & Consulting IRS Representation Payroll Services Business Consulting Debt and Financing Advising Financial Planning Litigation Support and Forensic Accounting Accounting & Bookkeeping Services

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