SEP-IRA Contribution Limits

SEP IRA stands for Simplified Employee Pension Individual Retirement Account. This type of fund offers limited filing requirements and paperwork, which makes it an excellent retirement savings vehicle for small business owners and other self-employed workers. With a SEP IRA, you can take advantage of deferred taxes on your contributions and deduct the amount of your contributions on your income tax return.

Current SEP IRA Contribution Limits

The maximum SEP IRA contribution for 2024 is $69,000, representing a significantly higher limit than for traditional and Roth IRAs. This high threshold is one of the reasons this type of investment account is so popular for sole proprietors and other independent business owners. However, these plans do not offer catch-up contributions or elective deferrals from your salary.

When funds are contributed to a SEP IRA, these contributions constitute employer contributions. Employers must contribute the same percentage of pay for each eligible employee as they designate for themselves. Self-employed individuals can contribute up to 25% of their annual net earnings to a SEP IRA.

SARSEP Contribution Limits

Elective deferrals are allowed for certain SEP plans called SARSEP plans, which were available before 1997. SARSEP stands for Salary Reduction Simplified Employee Pension. Grandfathered SARSEP plans had an elective deferral contribution limit of the lesser of 25% of total compensation or $23,000 in 2024. This limit does not include catch-up contributions. The limit is the same as the SEP limit for employee and employer contributions combined for the year.

Establishing a SEP IRA

If you want to take advantage of a SEP IRA, you must establish the account by your business’s tax deadline for the year in which you contributed to the account. For example, the tax deadline is in April. If you file an extension, your deadline will be in October. Even if you file an extension, you must pay any due taxes by the April tax deadline date (April 15th in 2024) to avoid interest or penalties.

Most banks and financial institutions that have IRAs also offer SEP IRAs. You can apply for this type of account through an investment firm or broker. When you open your account, you can manage your portfolio and create an investment strategy that incorporates a diverse array of stocks, exchange-traded funds, and mutual funds.

When you start a SEP IRA for your small business, you must make contributions on behalf of all eligible employees. This includes those who have worked for you in three or more of the last five years, who were paid at least $600 for the year in 2016 through 2019, and are at least 21 years old.

Otherwise, the operation of this type of IRA is quite similar to that of a traditional IRA. Withdrawals before age 59 1/2 carry a 10% fee as a penalty. Required Minimum Distributions begin at age 72 (waived in 2020). The first-year distribution must be made by the following April and by Dec. 31 of each year thereafter.

Keep in mind that account holders cannot receive a loan from a SEP IRA, nor can they use the assets within the account as collateral for a loan. In addition, you must keep contributing to an employee’s SEP IRA even after he or she no longer works for the company until the end of the plan term.

Calculating Adjusted Net Self-Employment Income

The formula for adjusted net self-employment income is gross income minus SEP IRA contributions and business expenses. Then, subtract 50% of the amount you pay in self-employment tax. A professional tax advisor can help you determine the limits that apply to your SEP IRA. Tax-deductible contributions are available only for plans open to contributions from non-SEP accounts.

Advantages of SEP IRAs

If you own a business, establishing a SEP IRA can help you save on your tax bill even without significant planning. These accounts are available for businesses of all sizes, from one individual to hundreds of workers. However, each employee must receive the same salary percentage as an annual contribution.

As discussed above, SEP IRA contribution limits are much higher than for other IRAs and for 401(k)s. As a comparison, the normal IRA limit for 2024 was $7,000 or $8,000 for those older than 50. The threshold for a 401(k) account in 2024 is $30,500 for individuals older than age 50 and $23,000 for all other investors.

Operational costs for this type of account are minimal, especially compared to the cost of operating a 401(k) plan. Unlike 401(k)s, most SEP IRAs do not require a setup or annual maintenance fee. Many 401(k) plans also have arduous requirements for administration that make compliance difficult for small business owners. A SEP IRA plan is free of these complex and time-consuming requirements.

With a SEP IRA, the business owner can take advantage of flexible funding each year. You can increase the contributions for employees in great years and limit contributions in less profitable times.

Consider this example: At age 30, you can begin putting $10,000 in a year in a SEP IRA that sees about a 6% return annually (note: this is based on average returns and this rate is not guaranteed). Although contributions equal $350,000 by age 65, the account will be worth almost $1.2 million. You may want to take this route to bolster your retirement savings if you have self-employment income through a side gig in addition to a salaried job with an employer 401(k).

Self-employed individuals and small business owners can also consider other appropriate retirement plans. Common options include standard 401(k) accounts, Keoghs, solo 401(k) accounts, and SIMPLE IRAs. Review the checklist provided by the IRS to determine if your small business is eligible for a SEP IRA. This helps you comply with IRS regulations and avoid costly penalties.

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