One of the best ways for self-employed professionals to save money for their individual retirement accounts outside of the traditional 401(k) includes the simplified employee pension IRA (SEP-IRA). However, there are contribution limits that you are required to stay within the limits of, as well as meet specific deadlines.
What are SEP-IRAs?
A SEP IRA plan allows business owners a method to save for retirement for themselves and all eligible employees. Businesses of any size, whether self-employed or a full-fledged organization, can set up a SEP plan.
Owners are able to invest money for each individual worker. It’s a rather simple account that can be managed with a small batch of paperwork, and there are no rules for annual filing.
SEP-IRA contributions behave as a tax deduction, providing the opportunity to grow earnings on a tax-deferred basis. No deposited money nor the gains from it are taxed until withdrawal. Furthermore, SEP-IRAs provide flexibility for funding with each calendar year, which is an important accommodation for businesses whose earnings consistently fluctuate.
Assets that are held inside of SEP-IRAs are treated as regular assets in the eyes of the law and are subject to most of the same rules.
Contribution Limits for SEP-IRAs
A particularly popular feature of a traditional SEP plan includes the significant amount of finances you can save for retirement. All employer’s contributions of SEP-IRAs are considered as made by an employer, acting as financial institutions, on behalf of the workers.
You are able to contribute up to a quarter of total compensation, or $61,000, whichever is lower. This is substantially higher than 2021, which had a maximum amount of $58,000. Furthermore, you’ll need to contribute an identical percentage for every worker if you plan to do so on behalf of everyone else.
Your specific compensation as a business owner is equivalent to your adjusted income for self-employment for the year if you plan to pay your own SEP plan. The upper limit may let you put more money into the SEP-IRA than other types of plans and often exceed what is found in traditional IRAs. For example, $7,000 for those above the age of 50 and $6,000 for the rest.
The limit of the 401(k) for individual workers is $20,500 for 2022 and $27,000 for those above the age of 50. These SEP-IRAs do not allow any way to catch up after the age of 49 in the same way that traditional IRAs and 401(k)s do, yet they are still considered higher contribution limits.
Self-Employment Income That Is Net Adjusted
People who are self-employed are required to utilize their net adjusted income for self-employment as compensation when calculating the 25% contribution limit for a SEP-IRA.
First, you need to calculate your business’s gross income, then subtract the expenses, including what was paid into the SEP-IRA. Next, subtract 50% of your self-employment tax to acquire your net adjusted income.
Contribution Deadlines
Similar to traditional ROTH IRA contributions, a SEP-IRA provides savings on tax at the last minute to reduce expenses as a business owner. However, in order to qualify, you are required to meet a specific SEP IRA contribution deadline.
For one, a SEP-IRA needs to be established by the tax deadlines of your company, including extensions, for the year in which the qualifying contribution will apply.
Like most individuals who file under their own name, the deadline to file tax as a sole proprietorship is usually April 15. If you ask for an extension, the due date will be pushed back to October 15. Keep in mind that this does not allow you any extra time to pay taxes due on the return.
There are similar deadlines for SEP-IRAs that apply when you contribute funds. Such SEP contributions are able to be made for the previous year until the deadline.
You can organize a SEP IRA account and pay until either April 15 or October 15. Be certain that you notify the IRA custodian to note the contribution for the previous year if that falls in line with your intention.
Keep Limits of SEP-IRAs In Context
There are various other options for retirement outside of a SEP-IRA plan for small business owners and self-employed individuals, including the individual 401(k), SIMPLE IRAs, Keoghs, and more. It is important you compare the various options available with financial advisors and decide on the one that fits your specific needs.
You can invest in a SEP-IRA if you are over the age of 21, worked with a business for at least 3 of the previous five years, and earned a minimum of $650 in the past year.
All contributions you make towards your SEP-IRA can be reported in Schedule 1 on line 16 if you happen to be self-employed. The total from Schedule 1 Part II transfers to line 10 of Form 1040. You need to report contributions made as it relates to SEP’s established tax year.
How to Establish a SEP IRA
You can create a SEP retirement plan for your business and all eligible employees through the execution of a formal agreement made in writing, known as the 5305-SEP. This can be acquired from an IRA custodian upon opening the account.
You need to provide all eligible employees with a copy of the form. This is not considered adopted until you provide all employees with the information. An IRA will be established on behalf of the custodian so that the employer can make contributions, and you can send funds directly to your trust company of choice.
The History of SEP-IRAs
The Revenue Act of 1978 established the contributory retirement account for small businesses. Furthermore, the 1981 Economic Recovery Tax Act (ERTA) made the IRA universally available as an incentive to workers under the age of 70.
At this point in time, the annual contribution limit was maximized to match 100% of the total compensation. When the 1986 Tax Reform Act was passed, restrictions on income were slowly introduced, which limited the availability of deductibles to those with income of less than $35,000 when under the plan of an employer.
The Small Business Job Protection Act of 1996 implemented the Savings Incentive Match Plan for Employees to provide contributions that matched employers together with employees as an alternative to the 401(k).
In 1997, the following year, the ROTH IRA debuted under the Taxpayer Relief Act. Contribution limits were increased in 2001 with the Economic Growth and Tax Relief Reconciliation Act and provided a catch-up provision to taxpayers beyond the age of 50.