Should I set up a SEP IRA if I'm self-employed?
If you're self-employed, setting up a SEP IRA can be an attractive and powerful option for retirement savings while allowing you to lower your taxes. Is SEP IRA right for you and your company?
What Is SEP IRA And How Can It Benefit You?
A SEP IRA is a retirement pension plan that you, as the owner, will offer to yourself and to your employees. In other words, self-employed individuals, freelancers, and other small business owners can provide retirement contributions to their employees through SEP IRA. It is similar to a traditional IRA but comes with a few extra benefits.
For example, the amount that an individual can contribute to a SEP IRA is much higher than a traditional IRA. The maximum you can contribute to your traditional IRA as of (2023) is $6,500. For SEP IRA the max for (2023) is $61,000 or 25% of the employee's total compensation. This allows self-employed individuals to save a larger portion of their income for retirement.
Another benefit to having a SEP IRA is the tax benefits. Contributions made by employers to a SEP IRA are typically tax-deductible, meaning they can be subtracted from the employer's taxable income. This can result in immediate tax savings for the self-employed individual. Additionally, the investment gains in a SEP IRA grow tax-deferred until withdrawal, providing potential tax advantages in the long run.
What Are The Requirements For Opening A SEP IRA?
To open a SEP IRA, business owners must have self-employment income and pay themselves with a W2 form. A business also must have one or more eligible employees to establish a SEP IRA plan. The eligible employees must be older than 21, have worked at least three out of the five years prior to making the IRA contribution and earned more than $650 (in 2022). With SEP IRA employees are not allowed to take loans from their account.
When you are setting up SEP accounts for employees, the amount you contribute to each account must be consistent: the same percentage of salary will apply to all. For example, if you contribute 10% of your income to your account, you must also contribute 10% of your eligible employee's income to their SEP account.
Employer can exclude the following employees from a SEP if: They are union members whose retirement benefits were negotiated by the union and are covered by a current collective bargaining agreement, if they are nonresident aliens who do not earn wages or other personal services compensation from their employer.
Additional Points To Keep In Mind:
SEP IRA does not offer a ROTH option. This means, when you pull the money out of your SEP IRA after you retire it will be taxed as ordinary income. However, with SEP IRA you will receive some tax benefits now which is also very important to small businesses.
The last date you can set up or contribute to a SEP IRA is the same as your tax filing deadline, including any extensions.
If your business is relatively new and you're still trying to get your bearings, a traditional IRA might be a better option for you since all eligible employees must be included in a SEP IRA. However, if you are serious about looking into a more robust retirement option for yourself and are interested in keeping competitive options for your valuable employees, a SEP IRA can be a very good option. If you would like to learn more about SEP IRA and would like to find the right financial vehicle, please schedule an appointment with us. Our financial professional can find the right plan for you and your company and design a plan to meet your retirement goals.