Content of the material
- 2022 SEP-IRA Contribution Limits
- SEP IRA Contribution Deadline
- Who can use a SEP IRA?
- Is a SEP IRA right for you?
- Key Features of SEP IRAs
- Employee Contributions and SEP IRAs
- Vesting and SEP IRAs
- Loans and SEP IRAs
- How Do I Open a SEP IRA?
- Keep SEP-IRA Limits in Context
- How to Set Up a SEP IRA
- SEP plan limits
- When can you set up a SEP plan?
- Related Questions
- Your Net Adjusted Self-Employment Income
- Tips for Saving for Retirement
2022 SEP-IRA Contribution Limits
Unlike other retirement plans, employees do not make their own contributions to a SEP-IRA. Only the owner of the small business can make them for employees. Employees are often free to still contribute to a separate IRA or Roth IRA.
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 $61,000, whichever is less.
Up to $305,000 of an employee’s compensation may be considered. These contribution limits reflect the 2022 tax year and apply to both employees of small businesses and the self-employed. For 2021, the limit was 25% of earnings up to $58,000.
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 $20,500 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 Deadline
A SEP-IRA can be established for the prior year and contributions made through April 15 or October 15 of that year. You may fund the account and contribute until April 15 or October 15 of the following year.
Who can use a SEP IRA?
Any employer, from a sole proprietor up through a corporation, can establish a SEP plan for its employees. Those high annual contribution limits (and the fact that they’re easy to establish — more below) make them a really great choice for armies of one — freelancers, contractors, and other self-employed people — or those with very few employees.
They’re typically not as great a choice for companies with a bigger team. With a SEP, the employer has to make the same contribution to every single employee’s account. That means if a business owner wants to put in the full 25% of her earnings for herself, she also has to contribute 25% of each of her employees’ earnings for them. That can get expensive. So keep that in mind if, for example, you think your company will grow quickly. Unless a company’s looking to offer especially generous benefits in order to reduce turnover, it’s an uncommon choice.
But no matter how many employees a company has, anyone who’s 21 years old, earns at least $600 a year, and has worked for the company in three out of the previous five years is eligible to get SEP contributions. But you can make these requirements less restrictive if you want.
Is a SEP IRA right for you?
Whether a SEP IRA is right for you depends largely on the nature and size of your business. Assuming you do not have a large number of eligible employees, SEP IRAs can be attractive because they confer the benefit of simplicity and are permitted to hold a wide range of securities.
Unlike 401(k) plans, SEP IRAs are administratively easy to establish and maintain. Most financial institutions have streamlined procedures, which include completing IRS Form 5305-SEP, to open SEP IRA accounts. Once you create individual accounts for yourself and your employees, each person is responsible for managing their own account.
Furthermore, with a SEP IRA, you can buy and sell a range of investments typically much wider than what is offered by other employer-sponsored plans — another benefit attractive to many investors.
Key Features of SEP IRAs
Employee Contributions and SEP IRAs
Some SEP IRA plans allow employees to make traditional IRA contributions to their SEP IRA account. This reduces the amount the employee may contribute to other IRAs. As an individual, in tax years 2021 and 2022 you are only allowed to contribute up to $6,000 ($7,000 if you are 50 or older) to all of your IRAs, including traditional, Roth and SEP IRAs. Any employer contributions do not affect how much you can contribute to an IRA.
Vesting and SEP IRAs
Employer contributions to an employee’s SEP IRA vest immediately, meaning that the employee has ownership of all assets in the account as soon as an employer makes a contribution.
That said, the rules of IRA withdrawals still apply. Workers generally can’t take the money early without paying penalties. If someone tries to withdraw money from a SEP IRA prior to age 59 ½, they’ll owe income taxes on the money as well as a 10% penalty, except under certain circumstances. They can, however, roll the funds into another IRA.
Loans and SEP IRAs
SEP IRAs, unlike 401(k) plans, aren’t permitted to make loans to participants. That said, it may be possible to make an early withdrawal from the account without paying a penalty in certain circumstances, including financial hardship, a first home purchase or higher education costs.
How Do I Open a SEP IRA?
Opening a SEP IRA requires that you put in place a written agreement to provide benefits to all eligible employees. The agreement must contain the name of the employer, what’s required for employee participation, the signature of a responsible official and a definite allocation formula. Many brokerages require you to have an Employer Identification Number (EIN) to open a SEP IRA.
You may be able to use the IRS’s model SEP plan document, Form 5305-SEP, unless one of the following situations applies:
• You maintain any other qualified plan, like a 401(k) or SIMPLE IRA
• You use the services of leased employees
• You want to use a non-calendar plan year
• You want to use an allocation formula that takes into account Social Security contributions you made for your employees
You may set up a SEP IRA with a bank, insurance company, mutual fund company or other financial institution that offers IRA accounts. You must apply to open the SEP, and each eligible employee must also submit an application.
A SEP can be established any time before a company’s annual tax filing deadline and can be used to make contributions for that tax year. For instance, if a sole proprietor’s tax deadline is April 15, 2022, to file taxes for tax year 2021, they may establish a SEP IRA anytime prior to that date and make 2021 contributions.
If there are eligible employees, employers must provide them with disclosures about the plan and allow them to enroll. This is true on a rolling basis: Once an employee becomes eligible, they must be informed. Each employee should receive a copy of the agreement containing participation rules and a description of how employer contributions may be made to the IRA, along with a copy of the completed Form 5305-SEP and a yearly statement showing any contributions to the plan.
Keep SEP-IRA Limits in Context
There are other retirement plan options for small businesses and self-employed persons, such as SIMPLE IRAs, individual 401(k)s, Keoghs, or regular 401(k)s. It makes sense to compare these options and decide which one is right for your needs.
How to Set Up a SEP IRA
You can set up a SEP retirement plan for all eligible employees by executing a formal written agreement, form 5305-SEP that you get from your IRA custodian when you open the account. You must give each eligible employee a copy of this form. The SEP isn’t considered adopted until you give each employee this information
An individual retirement account (IRA) is established for each employee by the custodian for the employer to make contributions. IRAR can help you establish your SEP and employees’ individual retirement accounts. Once the accounts are set up, you would send the contributions directly to IRAR.
SEP plan limits
Your contributions to your SEP plan (that is not a SARSEP) are not reduced by the contributions you or your employer make to your employer’s SIMPLE IRA plan.
SEP plans (that are not SARSEPs) only allow employer contributions. For a self-employed individual, contributions are limited to 25% of your net earnings from self-employment (not including contributions for yourself), up to $61,000 for 2022 ($58,000 for 2021; $57,000 for 2020). You can calculate your plan contributions using the tables and worksheets in Publication 560.
If your business sponsors another defined contribution plan in addition to your SEP plan (for example, a profit-sharing plan or a 401(k) plan), then your contributions for yourself to all these plans may not exceed 25% of your net earnings from self-employment (not including contributions for yourself), up to $61,000 for 2022 ($58,000 for 2021; $57,000 for 2020). Note that salary deferrals are not subject to the 25% limit and catch-up contributions are not included in the $61,000 limit.
When can you set up a SEP plan?
You may establish a SEP for a year up until the deadline of your company’s income tax return for the year in which you wish to set up the plan.
Have questions about our SEP-IRA? Here are responses to some of the most common questions we hear. If you have a specific question that’s not answered here, please call us at 800-435-4000.
- How do I establish a SEP-IRA plan?
To get detailed instructions see Establish Your Plan, or call us at 800-435-4000 if you have questions.
- Who is a SEP-IRA for?
A Simplified Employee Pension Plan (SEP-IRA) is specifically designed for self-employed individuals and small business owners who want to save for retirement without getting involved in complex plan administration. If you are self-employed or have few employees, and if you want flexibility in the amount you contribute annually—particularly if you want to make high contributions—a SEP-IRA might be right for you.
- What are the eligibility requirements for a business to establish a SEP-IRA?
Almost any type of business is eligible to establish a SEP-IRA, from self-employed individuals to multi-person corporations (including sole proprietors, partnerships, S and C corporations, and limited liability companies [LLCs]), tax-exempt organizations, and government agencies.
- What are the tax advantages of a SEP-IRA?
Employer contributions are tax-deductible. Earnings grow tax-deferred and are not taxed until they are withdrawn.
- How is a SEP-IRA funded?
A SEP-IRA is funded with employer contributions only. It does not need to be funded annually, but if you have employees and contribute for yourself, you must contribute for all eligible employees, including those who have terminated employment during the year. Full vesting is immediate.
- What are the SEP-IRA contribution limits?
You may contribute up to 25% of compensation (20% if you’re self-employed4) or $58,000 for tax year 2021 or $61,000 for tax year 2022, whichever is less.
- What is the contribution deadline for SEP-IRA?
A SEP-IRA can be opened and contributions made until the employer’s actual tax-filing deadline, including any extensions.
- When should I establish and fund my SEP-IRA plan?
Plans must be established by the tax-filing deadline of the business (generally April 15, plus extensions) in order to contribute for that tax year. This is also the deadline for annual contributions.
- What do I need to know about administering a SEP-IRA?
SEP-IRAs are easy to set up and maintain, and no tax filing is required. Schwab reports all contributions and end-of-year fair market value on Form 5498 by May 31 each year.
- What are the rules for withdrawing from a SEP-IRA account?
You can start making penalty-free withdrawals from your account after age 59½. If you do not start Required Minimum Distribution (RMD) withdrawals by age 70½ (if you were born before July 1, 1949) or age 72 (if you were born on or after July 1, 1949), or take less than the required amount, you will face a 50% penalty on the total amount of the distribution. There are certain exceptions for which you can withdraw funds before age 59½ without taking a 10% penalty, including a rollover to another IRA, some higher education expenses, qualified first-time home purchase expenses, death, disability, and certain medical expenses.
- What are the SEP-IRA rules?
SEP-IRA plans (Simplified Employee Pension) are designed to allow small-business owners or the self-employed to make sizable contributions to a retirement plan without filing a tax form. SEP-IRAs require little administration. Employees can contribute up to 25% of your annual income. If you’re self-employed, you can contribute 20% (after subtracting the self-employment tax deduction of your businesses’ net profit or equivalent to the employee percentage given). You can decide what amount to contribute each year, from $0 to the maximum SEP-IRA contribution, 25% of compensation (20% if you’re self-employed4) or $58,000 for tax year 2021 or $61,000 for tax year 2022, whichever is less. Rollover or transfer rules for a SEP-IRA are the same as traditional IRA plans. That means you can roll over funds to any qualified retirement plan, such as a 401(k). Distributions or withdrawals from a SEP-IRA are penalty-free after age 59½. If you do not start Required Minimum Distributions (RMDs) by age 72, you will face a 50% penalty on the total amount of the distribution. Withdrawals before age 59½ are subject to a 10% penalty. There are certain exceptions for which you can withdraw funds before age 59½ without taking a 10% penalty, including a rollover to another IRA, some higher-education expenses, qualified first-time home purchase expenses, death, disability, and certain medical expenses.
Your Net Adjusted Self-Employment Income
Self-employed persons must use their net adjusted self-employment income as their compensation when they're calculating their SEP-IRA contribution limit of 25%. First, determine your gross income. Now subtract your business expenses, including what you paid into your SEP-IRA. Now subtract half your self-employment tax. This is your net adjusted income.
Vanguard provides a useful calculator to help you figure out your maximum contribution to a SEP-IRA, but you might want to consult with a tax professional if you have other questions about how much you can pay in.
Workers can also make tax-deductible traditional IRA contributions to SEP-IRAs if the plan allows for this, but the ability to deduct these may be limited or eliminated because of your participation in the SEP plan.
Tips for Saving for Retirement
- Whether you’re a business owner or an employee, a financial advisor can be a big help in organizing your retirement accounts. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- 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.
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