SEP IRA Rules and Contribution Limits (GoodFinancialCents.com)

Updated : Sep 01, 2019 in Articles

SEP IRA Rules and Contribution Limits (GoodFinancialCents.com)


This is Jeff Rose, goodfinancialcents.com.
Are you a small business owner that wants to set up a retirement plan for your business,
but just have no clue on which is the right one for you? If you are, don’t worry. I was
in that exact same situation. Today I want to talk about the SEP IRA and what it is.
I want to tell you some of the benefits of how it might be a good fit for your business
and also when a SEP IRA might not make the most sense for you and your set up. First of all, what is a SEP IRA? A SEP IRA
stands for simplified employee pension. It’s a lot of words, but basically it is a retirement
plan that is set up specifically for small business owners. It allows you to put in a
lot more than you can in your traditional or Roth IRAs, and that is where we start with
the first benefit. Some of the first benefits of the SEP IRA
are like I just mentioned; you can put in up to $49,000 per year into it. Obviously
that far exceeds the $5,000 or $6,000 that you could do into a traditional or Roth IRA.
So $49,000 is a big chunk of change to be able to deposit in one year. How does that calculation work though? Here
is where it gets a little bit tricky. If you’re an S corporation or a C corporation or if
you’re an LLC that is going to be taxed as a corporation, than you can do 25% of your
W2 wages. Whatever income you decide to pay yourself out of your corporation, you would
then take 25% of that, which then determines how much you can put into the SEP IRA. To
be able to put the full $49,000 into a SEP for any given year, as you can see you have
to have a pretty handsome wage or income to be able to do so. If you’re a sole proprietor
like I have been, then instead of taking 25% of your wages, you take 20% of your net income.
That is how you determine how you can put into it. As you can see even though we are
only taking percentages of wages or net income, the amount you can put in far exceeds what
you can do in a traditional or Roth IRA and also the simple IRA, which I would call the
stepchild of the SEP IRA. One of the other benefits of setting up a
SEP IRA for your business is just that; they are easy to set up. Compared to setting up
a traditional 401K or even a solo 401K is there is a lot more IRS documentation, most
commonly known as the IRS form 5500, that you have to file each and every year when
you set up a solo 401K or a traditional 401K. With a SEP IRA it is not an ERISA-ran plan
so therefore there is no extra IRS documentation. It really is just a simple form that you fill
out and you’re good to go. Another benefit of setting up the SEP IRA
is that it’s very, very inexpensive to set up. Most solo 401Ks or traditional 401Ks are
going to have a set up cost and it differs with all the different carriers. Let’s say
on the low end $150. I have seen some on the higher end of up to $800, sometimes up to
$1,500. With a SEP IRA there is no set up cost. Typically the ongoing fee that you pay
is the IRA custodial fee that you’ll pay with a brokerage firm. This can be as low as $40,
on the high side maybe in the $75 range depending on where you go. Obviously if you’re using
an on-line provider it most likely is going to be a little bit cheaper than that. Nonetheless,
since you don’t have to file those extra forms with the IRS, the annual maintenance of that
SEP IRA is very, very inexpensive. One of the benefits I personally love about
the SEP IRA is that you are not bound to the same deadlines of putting your money in like
you are a traditional or Roth IRA. As most of you know, you have typically until April
15 of the following year to put in your contributions of your IRAs. For next year, for example you
have until April 15 to max out your IRA. With the SEP IRA you don’t have until April 15.
You actually can file an extension for your business and then you have until October 15
of that year to make the contribution for the previous year. Let me give you a personal
example. Every year for my business I always file an extension because I like to see where
I’m going to be at income-wise. If I think that I’m going to be at a higher income level
the following year, instead of putting a big chunk in for the previous year I’m going to
put in less last year and more in this year so I save more income tax. No other retirement
plan have I had where I have that ability to see where I’m going to be at income-wise.
You figure by October 15 of the following year you know where you’re going to be at
with income for the following year. That gives you enough time to gauge and see what’s going
to make the most sense for you and your business. Now that I’ve talked about the benefits of
the SEP IRA, let me give you a few examples of when a SEP IRA might not make as much sense
for you. In one area the SEP IRA might not make sense is if want to be able to put more
money in without being subject to that calculation we talked about earlier. In that case, that
is where a solo 401K might make the most sense. With a solo 401K you do have those numbers
you have to figure, but before you do any calculations you can immediately deposit the
$16,500 into the solo 401K. That is an added advantage of the solo 401K versus the SEP
IRA. I will tell you that is something I am looking at personally for the next tax year. Lastly, another situation that a SEP IRA might
not make sense is if you have several employees. Why, you ask? Because whatever percentage
you decide upon, say you’ve decided you want to put 15% of your net income into your SEP
IRA. Whatever percentage that you decide for yourself you have to do the exact same percentage
for your employees based off their income. If you have one key employee it might not
make that big a difference, but if you have five or six and you’re having to put 15% of
each of their income into their retirement plan it’s immediately invested. That means
that once you put it into their account it’s theirs. There is no taking it back. That might
take some careful thought and planning to see if those employees are right to be able
to receive such a large chunk. You can legally discriminate on some of those employees. Some
of the factors are if they are under the age of 21, if they only work so many hours a year,
and if they have not been with your company for a certain period of time. Be sure to check
the blog for more of those restrictions to see if they apply to you, but nonetheless
it is still something you want to consider before you start implementing a SEP IRA. I hope this was helpful in determining if
a SEP IRA is right for you and your business. If you have more questions, please feel free
to visit me at the blog of goodfinancialcents.com. If you’re on Facebook be sure to check out
our Facebook page and give us the big thumb. I’d love to see you around there. This is
Jeff Rose, Good Financial Cents. We’ll see you again.

11 Comments

  • Hey Jeff,

    Excellent demonstration. I appreciate your explanations on this topic, I've looked at many videos to send my current clients to and yours is by far the best out there on SEP IRAs. Thanks again

    -Derek Ifasi

  • Great video Jeff. I'm a consultant that is a sole practitioner and have had a SEP IRA for 17 years since I started my business. It's a great plan for high income sole proprietors that are savings minded because the contribution rules allow you to save such a high percentage of your income and give you the flexibility as you mention to decide how much to fund each year based on how well your business is doing. I rolled my 401k into my SEP when I left the corporate world to start my business and went from having about 10 mutual fund options to an online investment platform that offered the entire universe of publicly traded common stock, ETFs, mutual funds, bonds, preferred stock etc…etc…which allowed me to customize a retirement portfolio based on my risk tolerance and goals as well as re-balance asset allocations as market conditions changed and as risk tolerances and goals changed during the 17 years I've been in business. 

  • This was great, thanks for the info Jeff. For those that want to just update the numbers he gave with the new current year limits it is at: 
    http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/SEP-Contribution-Limits-(including-grandfathered-SARSEPs)

  • you didn't mention If the SEP has employer match. If there are 5 employees at 15% distribution into their SEP, isn't that each employee's own money out of their own check w/o employer match? if so, why is that a disadvantage to the employer?

  • Just started my sep ira last month. Been in business since 2011 and always just used a traditional ira, wanted to start throwing big money at retirement.

    Great vid

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