SEP IRA Retirement Plans for Small Business

Open your SEP IRA today!

    • IRS Form SEP 5305 (PDF)

      Have Questions? Contact a Certified IRA Specialist at IRASpecialists@QuestTrust.com. Forms and Requests Received Will be Processed in 24-48 hours of Quest Receiving the Form.

Employee Participation Requirements

  • An individual can open and make contributions to a SEP IRA if the following requirements are met:
  • Reached age 21
  • Worked for employer for at least 3 years
  • Received at least $600 in compensation

Distributions

    • A SEP follows the same rules as a Traditional IRA. A SEP IRA distribution is taxed as ordinary income the tax year of the distribution.
    • Required minimum distributions must be taken each year beginning with the year you turn age 72 (70 ½ if you turn 70 ½ in 2019).

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Maximum Annual Contribution

2022 tax year: As a small business owner you may be able to contribute up to 25% of your compensation or $61,000, whichever is less.

2021 tax year: As a small business owner you may be able to contribute up to 25% of your compensation or $58,000, whichever is less.

If you have employees, you may be required to contribute for them as well.

Disadvantages of a SEP IRA

Cost for larger businesses

There are a few reasons why a small business owner may want to choose a different type of retirement account. The biggest reason is the equal contribution requirement for the employer and employees. Only employers can contribute to a SEP IRA, and they must contribute the same percentage of salary for any eligible employees as they do for themselves. For employers who have a large amount of employees, this can be a deal breaker.

For example, let’s say a small business owner earns $225,000 in compensation a year, with two employees who earn $40,000 in compensation per year. For the owner to contribute the maximum amount of $56,250 (as this amount is the lesser of $58,000 or 25% of annual compensation) to a SEP account, the owner would also need to contribute 25% for each of the employees, costing an additional $20,000. If the owner has 20 employees who earn $40,000 in compensation, that additional amount for employees increases to $200,000 just to get $56,250 for the owner.

Less calculation flexibility

Contribution percentages are firm and cannot vary across employees with a SEP IRA. By comparison, a 401(k) plan could allow the owner to make a discretionary match that follows alternate calculations based on such things as employee age, department, or salary level.

No catch-up contributions allowed

Catch-up contributions (additional allowable contributions for individuals age 50 or older) are not available with a SEP IRA. This differs from the contribution limit rules for IRA and 401(k) plans. The lack of catch-up contributions is only a minor disadvantage, however, since the plan allows for greater contributions in total than those that allow the additional catch-up funds.

Hardship distributions and loans not allowed

401(k) plans have the option of allowing hardship distributions and/or loans from an employee’s 401(k) account. A hardship distribution is when a participant withdraws, without penalty, an amount from their retirement account to satisfy an urgent financial need related to specific reasons. SEP IRAs do not allow hardship distributions, and any funds withdrawn before the age of 59½ are subject to a 10% tax penalty, even if they are used for a hardship.

Loans from an employee’s account are also not allowed from SEP IRAs. Some employers may consider this a benefit, as 401(k) plan loans require a great deal of oversight and documentation. Because SEP IRAs do not allow this feature, it can decrease the administrative burden on the employer.

How to choose a SEP IRA plan provider

What to look for in a provider

Select a plan and provider that align with your business goals. There are three main areas we suggest you keep in mind: setup, cost, and investment options.

When it comes to plan setup, a key benefit of SEP IRAs is that they are easy to open and manage. When choosing a provider, look for one that provides a seamless, user-friendly experience. This includes great customer service, a setup process that is quick and easy, and a low-maintenance plan. Does the plan provider make it easy to roll over a previous retirement account? Is there a dashboard where you and your employees can check your balance, make contributions, and see your investments?

A major draw of SEP IRAs is their affordability, but administrative costs among providers vary. Look out for additional fees such as deposit fees, withdrawal fees, investment management fees, and account maintenance fees.

There are many different types of investment options a plan provider might offer to users. Ask yourself how hands-on you’d like to be. Would you rather hand-select from an array of stocks, bonds, and mutual funds? If so, look for self-directed accounts. If you want something simpler to manage, a provider that offers managed portfolios may be a better fit.

How and why to sign up with Guideline

At Guideline, our SEP IRAs offer professionally managed portfolios with automatic rebalancing. They are easy to set up, manage, and get support for when needed — all for just $8 a month plus a 0.08% annual account fee. You can open your account in about 10 minutes and start investing in your future.

Reporting Requirements

For the employer, tax reporting is limited to reporting SEP contributions on the business’s tax return. For individual participants, the IRA custodian or trustee reports SEP IRA contributions on IRS Form 5498 and distributions on IRS Form 1099-R.

Employers and employees should bear in mind that the custodians report contributions in the year they are received. If, for instance, ABC Inc. makes its SEP contributions for 2018 in May of 2019, Form 5498 may not correspond with the amount the employer reports for 2018. Employers should thus maintain their records to keep track of SEP contributions.

Ineligible Employees

Certain categories of employees may be excluded from participating in the SEP for the year, including those who:

  • Are covered under a collective bargaining agreement (unionized employees)
  • Are under age 21
  • Earned less than $650 (indexed for inflation) for the year
  • Worked less than three of the five preceding years
  • Are nonresident aliens with no U.S. income

How to Set Up a SEP IRA

It’s relatively easy to establish a SEP IRA.

You can open one at almost any bank, mutual fund company or brokerage firm. If you have employees, this financial institution will serve as trustee of the SEP IRA and hold each worker’s retirement plan assets.

You will need to follow these three steps:

Execute a written agreement to provide benefits to all eligible employees. Educate employees about the agreement. Set up an IRA account for each employee.

The written agreement must include your name, the requirements for employee participation, the signature of a responsible official and a set allocation formula.

Pro Tip

You may be eligible for a tax credit of up to $500 per year for each of the first three years for the cost of starting a SEP IRA.

The IRS provides a model SEP document on its website, Form 5305-SEP. Alternatively, you can use a prototype document provided by a mutual fund, bank, or other qualified financial institution. Or you can create your own.

The financial institution is required to provide a plain-language explanation of any fees and commissions it imposes on SEP asset withdrawals. As the plan sponsor, you should monitor the financial institution to ensure it is doing everything it is required to do and that its fees are reasonable for the services it provides.

If you use Form 5305-SEP, you must give your employees a copy along with instructions. This includes requirements for receiving a distribution from the plan and under what conditions you will allocate contributions.

After you make your first contribution, you and your employees will receive a statement from the financial institution. You should continue to receive a statement each year after that.

Establish a SEP Plan

The first action you’ll need to take is to choose a financial institution to serve as trustee of the SEP-IRAs that will hold each employee’s retirement plan assets. These accounts will receive the contributions you make to the plan.

Set-up steps for a SEP

There are three steps to establishing a SEP.

  1. Execute a written agreement to provide benefits to all eligible employees.
  2. Give employees certain information about the agreement.
  3. Set up an IRA account for each employee.

Written agreement

The written agreement must include the name of the employer, the requirements for employee participation, the signature of a responsible official and a definite allocation formula.

The IRS has a model SEP plan document, Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution AgreementPDF. Do not file this form with the IRS.

You may not use Form 5305 – SEP if you:

  • Maintain any other qualified plan (except another SEP – a plan is “maintained” even if no contributions were made during the year),
  • Use the services of leased employees,
  • Want a plan year other than the calendar year, or
  • Want an allocation formula that takes into account Social Security contributions you made for your employees.

If you can’t use the Form 5305-SEP, you may use a prototype document. A mutual fund, insurance company, bank or other qualified institution usually provides these. You may also have a SEP individually designed for your business.

Provide information to participants

You must furnish your eligible employees:

  • Notice that you have adopted the SEP
  • Requirements for receiving an allocation
  • The basis on which the employer contribution will be allocated

If you use Form 5305-SEP, you must give your employees a copy of the form and its instructions. The model SEP is not considered adopted until each employee is provided with the following information:

  1. A statement that IRAs other than the one the employer contributes to may provide different rates of return and contain different terms.
  2. A statement that the administrator of the SEP will provide a copy of any amendments within 30 days of the effective date along with a written explanation of its effects.
  3. The administrator will give written notification to the participant of any employer contributions made to a participant’s IRA by January 31 of the following year.

If you use a prototype or individually designed plan you must give all eligible employees similar information.

Set up a SEP-IRA for each employee

A SEP-IRA must be set up by or for each eligible employee. They may be set up with banks, insurance companies or other qualified financial institutions. All SEP contributions must go to traditional IRAs. Employees are responsible for making investment decisions about their SEP-IRA accounts.

You and your employees will receive a statement from the financial institutions investing your SEP contributions both at the time you make the first SEP contributions and at least once a year after that. Each institution must provide a plain-language explanation of any fees and commissions it imposes on SEP assets withdrawn before the expiration of a specified period of time.

Timing of setting up a SEP plan

You can set up a SEP for a year as late as the due date (including extensions) of your business income tax return for the year you want to establish the plan.

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SEP IRA rules

First of all, rather than limiting your annual IRA contributions to $6,000 — the maximum that workers under age 50 can contribute to traditional and Roth plans in 2022 — SEP IRAs allow a company to contribute up to the lesser of 25 percent of your compensation or $61,000. For workers who double as their own bosses, this also provides an opportunity to set aside more than they could in an employer’s 401(k), which caps 2022 contributions at $20,500.

The SEP is subject to the same investment, distribution and rollover rules as traditional IRAs, according to the IRS. While you can take distributions from your SEP IRA at any time, any withdrawals before the age of 59 ½ will be included in your taxable income and may be subject to a 10 percent tax penalty. Additionally, the IRS requires you to take required minimum distributions in the year you turn age 72, just as you would with a traditional IRA.

You’re eligible to contribute if you’re self-employed — even if you have other retirement accounts. If your business is a side hustle and you still have a regular employer, you can open a separate SEP IRA and contribute, while still socking money away in a 401(k). Plus, if you want a little tax diversity, a SEP IRA is different from a Roth IRA, so you can contribute to both accounts.

“For the self-employed individual, [a SEP IRA is] really an easy and cost-effective way to save a decent-sized chunk of money into a retirement plan,” says Tim Steffen, director of advanced planning at Baird, a financial advisor.

Realize, though, that if you end up hiring people, you need to treat them the same as you. Qualified workers who need to receive the same percentage from your employer contribution as you do include those who:

  • Are at least 21 years old
  • Earn more than $600 annually
  • Have worked in your business three out of the last five years

Keep that in mind as you move forward. If you contribute a large percentage of your earnings to a SEP IRA, you’ll have to contribute that same percentage of your employees’ income to their own retirement accounts. So consider your future plans. For some business owners, a SIMPLE IRA might offer a better solution.

If you open a SEP IRA at a brokerage, the account allows you to invest in potentially high-return assets such as stocks and stock funds. But you’ll also be able to invest in a whole range of securities offered by the brokerage, including bonds, options and more.

Related Questions

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.

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