SEP IRA

What is a SEP?

A Simplified Employee Pension IRA (SEP IRA) plan is a type of workplace retirement plan that allows an employer to contribute tax-deductible dollars to the owner's and the employee's retirement account. SEP IRA plans are funded solely by employer contributions (employee deferrals are not permitted); each eligible employee generally receives the same percentage of their individual compensation amount, and that percentage is at the discretion of the employer from year to year.

Benefits of a SEP IRA

SEP IRA plans offer a range of benefits, including:

• SEP IRAs are relatively simple and inexpensive
• Plans do not require special IRS filings or administration
• SEP IRA contributions are tax deductible to the employer
• Annual contributions to the plan are not mandatory and may range from 0% – 25% of compensation

SEP IRA rules

A SEP IRA plan can be established by any type of business, including a sole proprietorship, partnership, limited liability company (LLC) or corporation (S or C); a nonprofit organization; or even a government entity. It's important to consider the rules surrounding eligibility, contributions and distributions in determining the suitability of a SEP IRA.

SEP IRA eligibility

When the employer establishes a SEP IRA plan, they must decide on the eligibility requirements of the plan — which will vary based on their objectives. Everyone, including the business owner(s), is subject to these eligibility requirements. 

An employer can set up a SEP IRA with the following maximum eligibility requirements (but can choose to be more lenient):

• Age 21 or older
• Worked for the employer during three of the past five years, and
• Has current-year compensation of $750 or more (2023 and 2024) from the employer sponsoring the SEP

Like other retirement savings accounts, certain individuals may be excluded from a SEP IRA plan, including:

• Individuals covered by a collective bargaining agreement (generally union employees), whose retirement benefits were bargained for in good faith
• Non-resident alien employees who have received no U.S. source wages, salaries or other personal services compensation from the employer

SEP IRA contributions

Employers can contribute up to the following limits:

Contributions to SEP plans are tax deductible and grow tax deferred. Employees who receive contributions are immediately 100% vested.

SEP IRA contribution funding deadline

Employers must establish and fund the SEP IRA by the business's tax-filing deadline, including extensions.

Taxation of distributions

Distributions from SEP IRAs follow the same distribution rules as traditional IRAs and are typically taxed as ordinary income.  While distributions can be taken at any time, a 10% penalty on pre-tax dollars will be incurred if the individual is younger than 59½ and does not qualify for a penalty exception. 

Required minimum distributions

Individuals must begin taking a required minimum distribution (RMD) from their SEP IRA in the year they turn 73 and each subsequent year, even if still working.

SEP IRA  vs. SIMPLE IRA

SEP IRAs and SIMPLE IRAs are workplace retirement plans commonly used by small business owners. Here are some of the key differences between the two plan types:

• Who can contribute. Only the employer can contribute to a SEP IRA; employee contributions are not permitted. With a SIMPLE IRA, both the employer and employee can contribute.
• Flexibility of employer contributions. Employer contributions are not mandatory for SEP IRAs and may range from 0% – 25% of compensation annually. With a SIMPLE IRA, employers are required to make annual contributions of up to 3% of compensation.
• How much can be contributed. The contribution limits for SEP IRAs are higher than those of SIMPLE IRAs. However keep in mind that only the employer can contribute to a SEP IRA and the employer must contribute the same percentage of compensation to each eligible employee.

2024 Contribution Limits

 ¹ Certain SIMPLE plans can contribute up to 110% of the contribution limits.

2023 Contribution Limits

¹ Certain SIMPLE plans can contribute up to 110% of the contribution limits

2-year rule for SIMPLE IRAs. SIMPLE IRAs cannot be rolled over or transferred, receive a rollover or transfer, or be converted to a Roth IRA during the first two years (from the date of first deposit). Additionally, withdrawals taken before 59½ will be subject to a 25% penalty during the first two years unless a penalty exception applies.

Learn more about SEP IRAs

The low cost and simplicity of a SEP IRA can be appealing, but how do you know if it's right for you? Ask your local Edward Jones financial advisor for more information about all the options available for your plan. Contact us for a no-obligation consultation.