What is a SEP IRA?
The SEP IRA (Simplified Employee Pension) is a retirement plan for small business owners and self employed individuals. With a SEP IRA contributions are made by the employer to all eligible employees (employees do not contribute).The 2023 SEP IRA contribution limit is $66,000 and the 2022 SEP IRA limit is $61,000. Contributions made to a SEP IRA are generally 100% tax deductible.
SEP IRA Eligibility
Incorporated and unincorporated businesses are eligible. Sole proprietors, independent contractors, partnerships, LLCs, Subchapter S and C corporations qualify. Also, individuals with self employed income may be able to contribute to a SEP IRA even if they are already covered by a retirement plan (i.e. 401k or 403b) through their full time employer. There is no upper age limit to establishing a SEP IRA.
When is the deadline for a SEP IRA to be established and funded?
Sole proprietorship, partnership or a LLC taxed as a sole proprietorship
- A SEP must be established and funded by the individual’s personal tax filing deadline, generally April 15th (or October 15 if an extension was filed).
S or C corporation or a LLC taxed as a corporation.
- A SEP IRA must be established and funded by the corporate tax filing deadline, generally March 15th or September 15 if an extension was filed.
SEP IRA for a self employed individual with no employees.
Contributions of up to 25% of compensation up to a maximum of $66,000 can be made into a SEP IRA in 2023. can be made into a SEP IRA. For incorporated businesses, compensation is based on W-2 income and for sole proprietors it is based on “adjusted earned income.” Adjusted earned income is determined by completing an IRS worksheet. SEP IRA contributions of 20% of adjusted earned income can be made for sole proprietors. Annual compensation of more than $330,000 in 2023 cannot be taken into consideration for determining contributions.
Contributions into a SEP IRA are tax deductible and the percentage of contribution can vary on a year by year basis.
Self employed individuals should also consider a Solo 401k as an alternative to a SEP IRA. When compared to a SEP IRA, a Solo 401k may allow a greater contribution at the same income level due to the way the contribution is calculated.
SEP IRA versus Solo 401k: Which self employed retirement plan is better for you?
If you are self employed and do not have W-2 employees then you should consider a Solo 401k as well as the SEP IRA. Investors can potentially save more in a Solo 401k and Solo 401k plans allow 401k loans and SEP IRAs do not. Learn more about the Solo 401k.
SEP IRA for a small business owner with employees.
SEP IRA contributions are made by the employer (employees do not contribute). All eligible employees have their own individual SEP IRA accounts and annual contributions are made by the employer to the employer’s SEP IRA as well as to any eligible employees’ SEP IRA accounts. The employer can elect to contribute between 0% to 25% of compensation and the percentage of contribution can vary annually at the employer’s discretion. The employer and all eligible employees must receive the same fixed percentage. The annual contribution made by the employer is tax deductible.
Who is considered to be an eligible employee?
Employers must make contributions to employees if they meet the following 3 requirements:
- 21+ years old.
- Have at least 3 years of service in last 5 years.
- In 2023 have earned at least $750 in compensation from the employer.
Employers who would like to sponsor a retirement plan for their employees but are financially unable to make contributions on their behalf may want to consider a 401k plan. With a 401k, employers are not required to contribute and contributions can be made solely by employees.