Saving for retirement isn’t a top priority for many professionals or business owners until it’s too late. However, if you were late in making retirement contributions, high-limit plans such as cash balance plans, SEP IRA, and Solo 401ks offer generous contributions.
As a leader in defined benefit plans, especially the cash balance plan, we help clients create a sizeable retirement fund even if they start late. Cash balance plans excel against every other plan in terms of their contributions, allowing you to load up to $230,000 to your retirement plan every year.
However, most of our clients didn’t start with a cash balance plan, and we often get a call near the SEP IRA contribution deadline. With customers seeking additional ways to maximize their retirement savings, we guide them towards building a significant retirement corpus. Let’s start with the contribution timelines of a SEP IRA and later find the best way to boost your retirement savings with defined benefit plans.
SEP IRA Contribution Plan: Deadline, Contribution Limits, Tax Benefits, and More
SEP IRA plans present a simple, easy-to-maintain retirement plan for self-employed professional, business owners, and independent service providers seeking generous contribution limits.
Unlike conventional retirement plans, such as 401k or IRA, SEP IRAs come with higher contribution deadline and flexibility, especially if you’re an owner-only business or operate with few key employees.
SEP IRA Contribution Limit
Most of the people are drawn to a SEP IRA because of its high contribution limits. You can contribute the lesser of:
- 25% of your annual income; or
- $57,000 for 2020.
Although, you need to contribute the same percentage contributions, in accordance with their salary, to the SEP IRAs of qualified employees.
SEP IRA Contribution Example
If you’re a business owner with two eligible employees, Pete and Lisa, and have a personal income of $300,000, then your contributions for 2020 would look like this:
| SEP IRA | Income level | 5% | 10% | 20% | 25% |
| You | $300,000 | $15,000 | $30,000 | $57,000* | $57,000* |
| Pete | $80,000 | $4,000 | $8,000 | $16,000 | $20,000 |
| Lisa | $60,000 | $3,000 | $6,000 | $12,000 | $15,000 |
* Higher contribution limits kick in at $57,000, limiting your annual contributions to $57,000.
SEP IRA Contribution Deadline
If you operate a SEP IRA for your business, you must be aware of the SEP IRA contribution deadline. The IRS allows business owners to contribute to a SEP IRA plan until the final tax-filing deadline, which is April 15.
However, if you’ve applied for extensions, you can include the extensions within these timelines, up to a maximum of October 15 for any year.
However, if you miss this SEP IRA contribution deadline, you’ll not be able to deduct these contributions from your annual tax filing. Instead, you can rollover these contributions to the next tax season.
Timing to open a SEP IRA
You can open a SEP IRA until the tax-filing deadline, including extensions. However, we would suggest to do it at least a month before the deadline. You don’t want to cut it too close.
Tax Benefits and treatment of contributions
As an employer or self-employed professional, you receive a full tax deduction for your SEP contributions. If you’re self-employed or have freelance income, the SEP-IRA allows you to reduce your taxable income significantly.
Your contributions to employees’ SEP IRAs are not taxable to the employees.
The IRS doesn’t have any specific filing requirement for SEP-IRA contributions, although you shouldn’t mention these contributions on your employees W-2. Tick the retirement box column.
How cash balance plans maximize your retirement contributions
Now that we’ve gone through the contributions for a SEP-IRA plan let’s find out how cash balance plans help boost your retirement savings further.
Cash balance plans vs 401k, SEP IRA
A cash balance plan is a defined benefit plan, whereas a 401k is a defined contribution plan.
There are no set contribution limits for a defined-benefit plan. Instead, you consider the net benefits you want to pay to an employee or yourself and adjust contributions accordingly.
In 2020, you can contribute up to $230,000 to a cash benefit plan. A 401k, on the contrary, when combined with profit-sharing contributions, offers maximum contributions of $57,000, along with catch-up contributions of $6,500. A SEP IRA offers annual contributions of up to $57,000, with no catch-up contributions.
We made a comprehensive comparison of a 401k and Cash balance plan in this post.
How to set up a SEP IRA
Setting up a SEP IRA is relatively simple.
Written document
Stary by creating a written document for the SEP-IRA. You can use the model SEP plan document from the IRS or use a prototype document from a provider.
Inform employees
The next step is to inform your clients about the SEP IRA, qualifications for contributions, and any requirements for receiving contributions.
You may inform clients about other details such as SEP IRA contribution deadline or limits, but the IRS doesn’t mandate sending these notices.
Set up SEP IRA
The final step is to create a SEP IRA for all the eligible employees. You can choose any bank, financial institution, or third-party providers for the SEP-IRA.
Now that your SEP IRA is set up, we suggest being cautious about critical timelines, such as SEP IRA contribution dates, the establishing schedule, etc.
How do you report SEP IRA contributions?
There are no filing requirements for SEP-IRA contributions, making management quite easy. However, you do need to send a copy of the SEP plan document to eligible employees at the time of plan establishment.
The IRS requires you to provide employees with an annual SEP IRA contribution statement, along with any change in plan structure or qualification rules.
Bottom Line
As a business owner, you’re used to consistent cash flow, income, and financial affluence. Having a retirement strategy allows you to maintain your current lifestyle in retirement as well.
SEP IRAs are ideal for individuals seeking low to modest retirement savings, but if you’re trying to supercharge your retirement fund, a defined benefit plan, such as a cash balance plan, will serve the purpose better.
