Looking for the best SEP IRA providers? We put together this comprehensive guide to help you find everything you must know about SEP IRAs.
At Emparion, you may already know that we are known for our cash balance plans and defined benefit plans. We don’t set up SEPs. But we know the players in the industry very well.
If you want to make annual retirement contributions of $100,000 plus, then you would need to talk to us about a cash balance plan. But if you are looking to get a smaller amount into retirement, then a SEP IRA may work great for you.
How does a SEP Compare to a Cash Balance Plan?
Financial security in retirement is one of the gravest challenges Americans face in 2020. Nearly 6 out of 10 Americans didn’t have a retirement account or access to a pension in 2018. The trend doesn’t just stop there.
If you’re a small business owner or self-employed professional seeking a retirement option for yourself and your employees, a Simplified Employee Pension IRA (SEP-IRA) can offer significant advantages over many traditional retirement accounts.
At Emparion, you know our plan of choice is the cash balance plan. You can find out more about them here. A SEP is great if you want to put $10,000 to $30,000 into a plan. But what if you are looking to get $100,000+ into a plan? The SEP just won’t work.
Because of the large contributions, the cash balance plan may be your best solution. But if you want to make smaller contributions and your income varies from year to year, the SEP is a great option. So let’s dive into the details.
What is a SEP IRA?
A Simplified Employee Pension IRA is a retirement savings account built for small-business owners and owner-only businesses. It offers relatively high contribution limits ($57,000 in 2020), tax deductions, and deferred growth of investments until distribution.
Eligibility criteria for SEP IRA
You can open a SEP IRA if you’re an owner-only business, small business, or have freelance, professional income. In case you work part-time or provide professional services in addition to having a regular 9-to-5 job, you qualify for a SEP IRA plan nonetheless. You can operate a SEP-IRA along with a 401(k) offered by your employer.
Contribution rules for SEP IRA
SEP IRAs are famous for their higher contribution limits, allowing you to contribute up to $56,000 in 2019 and $57,000 in 2020. The IRS revises this limit every couple of years, taking into account cost-of-living adjustments.
The IRS allows you to contribute up to 25% of your professional income to the SEP-IRA. If you’re self-employed, the contribution rules vary a little; you can refer to IRS Publication 560 for more clarification.
If you have one or more qualifying employees as participants in the plan, you need to make a proportional contribution to their accounts as well. The contribution deadline is the same as that of the tax-filing period, April 15, or higher if you have an extension.
As an employer, it is your responsibility to calculate contributions for your employees in accordance with the guidelines set in the Internal Revenue Code.
Pro Tip: If you made a contribution error, the IRS allows you to correct your mistake within a given time frame. Here is a guide from the IRS to fix any errors in the SEP-IRA.
Withdrawal rules
When it comes to withdrawals, the IRS requires you to start taking contributions no later than 70½ years. The IRS offers a detailed guide about required minimum distributions, rollovers, and taxation of these distributions in Pub. 560.
In case of premature withdrawals, those before age 59½, the amount will be included in your gross income and will be taxed as per applicable income tax rules. Additionally, you or the employee will end up paying a 10% penalty for early withdrawals.
Pros of the Best SEP IRA
- Sizeable contribution limits: One of the primary benefits of SEP IRAs is its high contribution limit. It allows you to make a substantial annual contribution in comparison to traditional IRAs or 401(k) plans.
- Tax-deferred growth: Any investments or contributions you make to the SEP-IRA enjoy tax-deferred growth. It is an excellent solution to cut your taxable income. Additionally, the IRS allows you to deduct employee contributions from net business income, making it an even better deal.
- Easy setup and management: SEP IRAs are quite simple to set up and administer. The only part that requires expertise is calculating eligible contributions for yourself and the employees.
- Flexibility: Since small business owners may find it challenging to contribute every year, SEP IRAs offer flexible contribution rules. You don’t have to contribute annually to the plan.
- Work along with IRAs or a Roth IRA: You can open a SEP IRA along with a traditional employer 401(k), IRA, or Roth IRA. Although you have to be careful while calculating annual contributions to each of these plans.
Cons of the Best SEP IRA
- No catch-up contributions: SEP IRAs do not offer catch-up contributions, unlike other similar plans such as Solo 401k or independent 401k, traditional IRA. It could be a slight disadvantage for owners or plan participants above 50 years.
- Lacks in-built Roth option: There is no Roth version of SEP IRA, which means you must open a separate Roth IRA for after-tax contributions.
- Employee contributions: One of the biggest limitations of SEP IRAs is the required employee contributions. You’ll have to make proportional contributions for every plan participant. This, in turn, could increase the cost for businesses with multiple employees.
- Premature withdrawals are taxed: While it may not come as a limitation since the IRS penalizes early-withdrawals for different plans, but you must remain careful of these rules.
- Required minimum distributions: You must take required minimum distributions after reaching 70½ years.
Who is it ideal for?
As a provider of retirement solutions for individuals, self-employed professionals, and small businesses, we recommend SEP-IRA to owner-only firms or companies with fewer employees. Business owners can make significant taxable savings through regular contributions.
Additionally, SEP IRAs offer flexibility in contributions, making it a good retirement plan for small businesses with unpredictable income. These plans are easy to open, incur lower costs, and comparatively cheaper to manage.
SEP IRA Vs. Solo 401k Vs. Traditional IRA
SEP IRA Vs. Solo 401k
Both SEP IRA and Solo 401k plans are designed for small business owners and self-employed professionals. Each of these plans requires self-employment for eligibility.
SEP IRA allows you to add key employees under your plan, whereas Solo 401k plans are available for owner-only businesses or self-employed professionals.
Solo 401k accounts excel in providing catch-up contributions for professionals above 50 years and offer built-in Roth features. SEP IRA, on the contrary, does not provide any of these benefits.
How does it compare to a traditional IRA?
One of the critical differentiators between the best SEP IRA and the traditional IRA is that of contribution limits. You can contribute up to $57,000 to SEP IRA in 2020, whereas an IRA permits annual contributions of only $6,000 or $7,000 for those above 50 years.
SEP IRAs are beneficial for professionals or older business owners seeking to maximize their retirement contributions. Each of these plans is easy to set up and administer.
Traditional IRAs do provide catch-up contributions, but SEP IRAs more than compensate for this feature with higher contribution limits.
Who are the best SEP IRA providers?
A recent survey finds that more than 34% of small business owners do not have a retirement savings plan. At least 2 out of 5 business owners cite a lack of sufficient profits as the primary reason for avoiding retirement planning, whereas 21% used their retirement savings to invest in their business.
SEP IRA provides one of the best opportunities for business owners to boost their retirement contributions. Also, it allows you to attract and retain key employees even if you’re a small business owner.
Small business owners, who are deemed to be financially savvy, are equally unprepared for retirement.
When it comes to retirement planning, always remember that the best time to start saving was either when you were 21 years old or now; don’t delay it any further. You’re the one responsible for taking care of you.
I have heard about cash balance plans but don’t know much about them. What is the different between a cash balance plan and a SEP? I’m just not sure what the best option for me is.
There are big differences between cash balance plans and SEPs. But the key takeaway is that a SEP is a great plan if you are only looking to do a modest contribution like $20k or so. If you want to put in $100k or so then you would want to do a cash balance plan. So even though you can contribute substantially more to a CBP than a SEP, they are permanent plans and of course more expensive to maintain. But if you are looking to maximize your retirement contributions then a cash balance plan is usually your best bet.
What happens when company grows, and I can no longer afford SEP IRA? Can I leave it parked, and start a regular 401k for the company? Any issues or concerns to watch out for?
If you don’t want to contribute to the SEP and want to move up to a 401k that is fine. You can leave the SEP alone or just roll it over into the 401k or an IRA. Just make sure you don’t contribute to both plans in a given year.