What is a SEP IRA?
Key Facts
- SEP IRAs are similar to traditional IRAs but are for self-employed individuals or small business owners
- A key advantage of a SEP IRA is the higher contribution limit; for 2020 you can contribute up to 25% of income or $57,000, whichever is less
- Like a traditional IRA, SEP IRA contributions are tax-deductible and money is not taxable until withdrawal
- A SEP IRA is best for self-employed workers who have very few or no employees and want flexibility in the amount you save (for example, if you want to tie contributions to profits).
Self-employed individuals and responsible small-business owners understand the importance of helping themselves and their employees save for retirement. But expensive employer-sponsored plans used by large corporations aren’t always practical for those running their own companies, or small- and medium-sized businesses. Fortunately, there is a simple solution that makes it easy to support employee retirement savings: the Simplified Employee Pension Individual Retirement Account (SEP IRA).
SEP IRAs offer tax benefits to employees and employers. Employer contributions are not included in employees’ gross income, so employees do not pay income taxes until they take distributions. Employers may be able to deduct contributions to employees’ SEP IRA accounts from the tax returns filed by the business.
How Does a SEP IRA Work?
The SEP IRA definition is similar to the definition of a standard IRA; however, contributions to SEP IRAs are made exclusively by employers or the self-employed. The IRS regulates who can participate in a SEP IRA, which includes the following criteria:
- aged 21 and older
- worked for the sponsoring employer three out of the previous five years
- has received at least $600 in compensation from the employer
Employers offering SEP IRAs can make the participation requirements less restrictive than IRS guidelines, but they cannot make participation more restrictive. It’s important to note that the minimum compensation amount is reviewed by the IRS annually and is adjusted based on cost of living.
SEP IRA Contributions
Other limits apply to SEP IRA contributions. For example, as of 2020, the maximum contribution employers are permitted to make on behalf of employees is 25% of total compensation or $57,000, whichever is less.
Finally, when calculating contribution amounts, only the first $285,000 of employee income can be considered. For example, an employer chooses to make a contribution equal to 10% of employees’ annual salary. Employees with a pay rate of $300,000 receive a contribution of $28,500, which is 10% of $285,000 instead of 10% of $300,000. The $57,000 and $285,000 figures are also subject to annual review and revision.
| 2020 | 2019 | 2018 | |
| SEP Minimum Compensation | $600 | $600 | $600 |
| SEP Maximum Contribution | $57,000 | $56,000 | $55,000 |
| SEP Maximum Compensation | $285,000 | $280,000 | $275,000 |
Disclosure
Nothing in this article should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This article is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Financial advisory services are only provided to investors who become Wealthfront clients.
This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.