Maximizing Retirement Benefits: A Guide to SEP-IRAs for Small Businesses
In an era where retirement planning is essential, small businesses often struggle to find accessible and cost-effective retirement solutions.
Luckily, a handful of retirement plan options work well for small businesses.
Among these, the Simplified Employee Pension plan, or SEP-IRA, stands out as versatile.
This article explores SEP-IRAs, offering insights into eligibility requirements, contribution limits, deadlines, and withdrawal rules.
What’s a SEP-IRA?
A Simplified Employee Pension plan, known as a SEP-IRA, is a straightforward retirement plan for small business owners and self-employed individuals.
It enables employers to make tax-deductible contributions to individual retirement accounts for themselves and their employees within specific limits without intricate plan administration.
Only the employer funds a SEP and employees fully own all the money in their SEP-IRA from the start.
Why Set Up A Retirement Plan for Your Business?
Establishing a retirement plan for your business, such as a SEP-IRA, is a strategic move that offers a multitude of benefits:
- Firstly, it’s a powerful tool for attracting and retaining top talent within your organization. In today’s competitive job market, offering a comprehensive retirement plan can set your business apart from competitors and act as a compelling incentive for prospective employees. Moreover, by providing a means for employees to save for their futures, a retirement plan demonstrates your commitment to their long-term financial well-being, fostering loyalty and engagement.
- From a financial perspective, setting up a retirement plan can yield significant tax advantages for your business. Contributions made to a SEP-IRA are typically tax-deductible for the employer, and your company pays no taxes on the investment earnings. Eligible employers can claim a tax credit of up to $5,000 for three years to cover the ordinary and necessary costs of starting a SEP. This tax credit directly reduces the amount of taxes owed, dollar for dollar. To qualify, your business must have had 100 or fewer employees who earned at least $5,000 from you in the previous year. Speak to your tax advisor for more information.
- With a SEP-IRA, individuals can contribute substantially more (nearly 10x) than traditional IRAs. For comparison, the contribution limit for a traditional IRA in 2024 is set at $7,000, with an extra $1,000 catch-up contribution available if you are 50+. On the other hand, SEP IRAs allow contributions up to 25 percent of your compensation or $69,000. Higher contribution limits enable greater retirement savings potential, fostering financial security and flexibility, which is particularly advantageous for self-employed individuals and small business owners.
- SEP-IRAs demand minimal administration, simplifying retirement planning for small businesses. There are no annual Form 5500 filings or complicated compliance requirements with the IRS. This ease of management allows business owners to focus on their core operations while providing valuable retirement benefits to employees.
Eligibility Requirements for Establishing a SEP-IRA for Your Business
Any business can set up a SEP-IRA.
Once a business creates a SEP plan, it is required to offer this retirement benefit to all eligible employees. This ensures that everyone who meets the criteria has access to the plan.
You MUST include an employee in the SEP plan if they:
- Are at least 21 years old
- Have worked for the company for three of the past five years
- Have received at least $750 in compensation from your business in the years 2023 and 2024 ($650 in 2021 and 2022, with cost-of-living adjustments). For earlier years, the thresholds were $600 from 2015-2020 and $550 from 2009-2014.
Your plan can have less strict requirements to determine employee eligibility. For instance, it might allow employees as young as 18 or those with just three months of service to participate. This flexibility helps more employees qualify sooner.
For more information on eligibility requirements, please refer to Retirement Plans FAQs regarding SEPs | Internal Revenue Service (irs.gov).
SEP-IRA 2024 Contribution Limits
Employees cannot contribute to their SEP-IRA accounts; employers make all contributions.
The contribution limit for SEP-IRAs in 2024 is up to 25% of the employee’s (or owner’s) compensation or $69,000, whichever is less ($66k for 2023; $61k for 2022; $58k for 2021; $57k for 2020 & subject to annual cost-of-living adjustments for later years).
This generous limit allows businesses to contribute substantially to employees’ retirement savings. However, it’s important to note that the same percentage of compensation must be contributed to each eligible employee’s account, including the owner.
The business owner retains absolute flexibility in contributions, provided each eligible employee, including the owner, meets the plan’s criteria outlined in the Adoption Agreement. Contributions can be adjusted annually, skipped intermittently, or initiated in one year and discontinued afterward.
What Is the Contribution Deadline for SEP IRA?
Your SEP-IRA contributions must be made by the federal income tax deadline each year, typically around April 15th of the following year. The deadline for the 2023 contribution year was April 18, 2024.
Withdrawal Rules for a SEP-IRA Plan
Employees can withdraw SEP contributions and earnings whenever they choose. The withdrawal will be taxed in the year it is taken. Generally, withdrawals made before age 59½ may incur a 10% penalty*.
A mandatory minimum distribution must be made by April 1 of the year after the employee turns 72 (or 70½ if they reached that age before January 1, 2020). The law allows this first required distribution to be made by April 1 of the year after turning 72 (or 70½ if applicable). After that, distributions must be made annually by December 31.
You must start withdrawing from your SEP-IRA by age 73 (or 75 if you turn 74 after December 31, 2032).
*There are exceptions for penalty-free withdrawals before age 59½, including IRA rollovers, qualified first-time home purchases, higher education expenses, death, disability, and some medical expenses. However, it’s essential to know that income taxes may still apply in these cases.’
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.