It can be worrisome to think about your retirement savings if you’re self-employed or work for a small business. You don’t have to go without retirement savings, though. That’s where a SEP IRA comes in. As with other IRAs, SEP IRAs will have limitations as to how much you can contribute and withdraw. Let’s take a look at the latest SEP IRA contribution limits.
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What Is a SEP IRA?
A SEP IRA is a retirement savings vehicle tailored toward self-employed workers and small business owners. A SEP IRA is a traditional IRA under a SEP plan. “SEP” stands for Simplified Employee Pension. Essentially, a SEP IRA serves as an easier way to save, tax-deferred, for retirement for small business employees and the self-employed.
It’s important to know whether you’re eligible to open a SEP IRA. First off, you must be a sole proprietor, a business owner in a partnership or earn self-employment income. You may also open a SEP IRA if you have a side gig that earns self-employment income.
SEP IRAs provide a few advantages for those who can use them. For starters, SEP IRA contributions qualify as tax-deductible business expenses. SEPs also tend to come with lower administrative costs than other retirement accounts. Plus, as an employer, you don’t have to contribute every single year. You contribute when it makes sense for your business, allowing for some flexibility.
You must start making required minimum distributions (RMDs) from your SEP IRA by age 70 ½. If you make any withdrawals before age 50 ½, you’ll trigger a 10% penalty.
SEP IRA Contribution Limits
There are a couple of limitations when it comes to SEP IRA contributions. An employer can contribute to an employee’s SEP IRA up to either 25% of the employee’s compensation or $54,000, whichever is less. Up to $270,000 of an employee’s compensation may be considered. These contribution limits reflect the 2017 tax year and apply to both employees of small businesses and the self-employed.
Those who have a Salary Reduction Simplified Employee Pension (SARSEP) plan that was established before 1997 were entitled to make elective salary deferral contributions. If you still have your plan, you can make elective deferral contributions up to $18,000 or 25% of your compensation, whichever amount is less.
It’s important to note that you cannot make elective salary deferrals or catch-up contributions to regular SEP plans. You also cannot contribute property to a SEP IRA. All contributions must be made in cash. If you accidentally contributed more than the limits allow, visit the IRS website to learn how to correct the contribution mistake
SEP IRA Contribution Rules
You must make your SEP IRA contributions by each year’s federal income tax due date. If you have a tax extension, you must make the contributions by the end of the extension period. If you miss the deadline, you cannot deduct any SEP plan contributions on that year’s return. You can deduct the contributions on the following year’s tax return. To report your contributions, you use Form 5498, shown here.
As an employer, you will need to make contributions to your employees’ SEPs proportional to each employee’s wages. Each employee will receive contributions of the same percentage. In the same vein, you must contribute the same percentage to your employees’ plans as your own. If you are self-employed, you will base your contribution on net profit, minus one-half of the self-employment tax.
You do not have to contribute to an SEP each year. When you do make contributions, though, you must make them for all eligible employees. You must also make a contribution even for a participant who is not employed on the last day of the year. An SEP cannot have a last-day-of-the-year employment requirement. Additionally, if an employee is over the age of 70 ½, they must still receive contributions if they are eligible. They will also be making withdrawals at that point.
Participating in an SEP plan does not necessarily limit you from making regular IRA contributions. You will have to make sure your SEP plan allows for it. If you are 50 or older, you may also make IRA catch-up contributions. Those contributions must still follow regular IRA contribution limits. These contributions may limit the amount of the regular IRA contribution that you can deduct on your income tax return, as well as the amount you can contribute to other IRAs like a Roth IRA.
SEP IRA Tax Implications
When it comes to deducting SEP IRA contributions on your business’ tax return, you can deduct up to the lesser amount of your contributions or 25% of your compensation. Employees are not subject to taxes according to their employer’s contributions. This is because SEP IRA contributions are not included in an employee’s gross income. If you are self-employed, the IRS has different steps to figure out your own maximum deduction.
If you make excess contributions to a SEP IRA, then those are considered an employee’s gross income. To avoid a tax penalty, you will have to withdraw that excess amount before the due date of your federal tax return. Should you fail to make the withdrawal on time, you’ll face a 6% tax on the excess contributions. In addition, the employer may face a 10% excise tax on the excess amount.
To reap all the tax benefits of a SEP plan, you’ll have to meet all of the IRS’ requirements. If you make any mistakes regarding contributions or withdrawals, you’ll lose out on those tax benefits. However, the IRS does leave room for you to correct any mistakes before your federal tax return due date.
The Bottom Line
A SEP plan allows small business owners and the self-employed to participate in structured retirement accounts. It’s always important to keep up with account contribution limits, SEP IRAs included. This way, you can make the most of your IRA, but also avoid some big tax hits. Luckily, if you do accidentally make an excess contribution, the IRS allows you some time and options to reverse it.
Tips for Saving for Retirement
- It’s incredibly important to take advantage of your company’s 401(k) offerings if available. That way, you can set the contribution limit and forget it, instead of worrying about contributing to an IRA.
- Without a huge and steady income in retirement, you might be worrying about how much of a tax hit you’ll see each year. Further, your tax hit will depend on where you choose to retire. Check out this tax-friendliness calculator to determine where you can pay less taxes in retirement.
- Work with a financial advisor. According to industry experts, people who work with a financial advisor are twice as likely to be on track to meet their retirement goals. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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