Considering the SEP retirement plan as an option? Like many small business owners, you probably find yourself very busy in the wake of the COVID slowdown. But that is not a valid reason to neglect your future. Especially as there are a number of retirement plans available, including Keogh plans and 401(k)s. However all in all, once you learn the benefits, a SEP retirement plan may be your best option.
What IS a SEP retirement plan?
SEP, or simplified employee pension plan, is a retirement plan that either an employer or a self-employed individual can establish. One just deposits retirement contributions into a traditional IRA account. Thus eliminating most of the employer’s administrative duties. This is why a SEP is sometimes referred to as a SEP-IRA.
SEPs function much like Keogh retirement plans. However SEPs allow tax-deductible contributions for both employees and self-employed individuals. For an employee, the maximum contribution for 2021 is the lesser of 25% of that employee’s compensation or $58,000. Contributions are excluded from employees’ wages. They are also not subject to withholding taxes. A self-employed person can contribute 25% of his or her compensation after deducting the employer’s contribution. This boils down to the smaller of 20% of the business’ net profit or $58,000. Each year, the employer can specify a compensation amount between zero and 25% (not exceeding the maximums for the year).
Who is a SEP retirement plan good for?
SEPs are a great option for startups and other small businesses that have unpredictable income. They are also good for anyone not enjoying long-term contribution matches required with other types of retirement plans. SEPs are also a great option for self-employed individuals with no employees. This is because contributions are based upon net profits. The benefit of this allows the business owner to select the maximum percentage, knowing that the required contribution will be low in low-income years.
Employers choosing to make SEP contributions must contribute to an employee’s SEP when:
- the employee is at least 21 years of age
- has worked for the employer in at least three of the prior five calendar years
- 2021 has compensation of at least $650.
The compensation floor is subject to inflation adjustment annually and had been $600 from 2015 through 2020.
*Except for when employees are union members covered by collective bargaining agreements.
Advantages of a SEP retirement plan
Advantages of a SEP retirement plan include that contributions are allowed after the account owner turns 72. (Thus must begin taking required minimum distributions from the plan.)
As with all traditional IRAs and qualified plans, distributions from a SEP are taxable. Also a SEP is subject to a 10% early withdrawal penalty if funds are withdrawn before age 59½.
A SEP-IRA must be set up for each eligible employee. One may set up an SEP with a bank, an insurance company or other qualified financial institutions. When setting up a SEP plan, you can adopt the IRS model plan by using Form 5305-SEP. Alternatively, adopt the plan offered by the financial institution you will be dealing with. (The latter is the best option.) If using a financial institution’s plan, be sure to discuss the plan’s fees.
SEP’s can be established and funded up to the business’ income tax return due date.
In short, a SEP may be the best option for your business’s retirement plan. Please call this office for more information on how a SEP plan might work for your particular business structure or to determine whether other options should be considered.
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