What is a SEP IRA?ReviewAdviceFAQ's

What is a SEP IRA?

A SEP IRA, which stands for Simplified Employee Pension, is a retirement account for self-employed individuals (such as freelancers) or small business owners. SEP IRAs follow the same rules as traditional IRA's, including withdrawals taken during retirement being taxed as ordinary income.

For individuals without employees, a SEP IRA is appealing because the annual contribution limits are higher than with any other IRA account. The limit that you can contribute to your own retirement is currently 25 percent of your total income or $52,000 (as of 2014), whichever is less. Since contributing to a SEP IRA lowers your taxable income, this can significantly reduce your annual tax bill if you're a high earner.

If you have employees, you can open a SEP IRA for yourself and your eligible employees can also open their own SEP IRAs that you contribute to. Employees do not contribute to SEP IRAs, only employers do. All contributions to both your own account and your employees' accounts are tax deductible, allowing you more tax dollar savings each year. Another advantage to the SEP IRA versus traditional IRA accounts is that employers are not required to make contributions every year. If you have a slow year, no problem, you can simply skip the annual contributions without paying a penalty.

Employee Eligibility

In order for an employee to be eligible for a SEP IRA, they must meet three requirements:

  • Be at least 21 years old
  • Have worked for the business for three of the last five years
  • Received $550 or more in compensation during the year

Opening a SEP IRA for your employees is a great way to show loyalty to those that are working for you. Typically, benefits offered by a business are just as important as the salary. By offering retirement options to your employees, you will likely reduce turnover and attract more qualified candidates.

What is a SEP IRA?

Benefits of SEP IRAs

One of the biggest appeals to SEP IRAs is that they are incredibly easy to set up. You simply make a phone call to your preferred investment firm and start contributing. Other benefits include:

Large contribution caps. As stated above, you can contribute 25 percent of your income or $52,000 (as of 2014), whichever is less. While that number is high, it's a great way to play catch up on your retirement savings if you're behind and are earning a high income. Whatever amount you contribute comes right off your taxable earnings, making it so you owe less in taxes each year.

You can make last-minute contributions. SEP IRAs are similar to traditional IRAs in that you can make last-minute contributions when you go to file your taxes. For 2014, for example, you have until April 15th, 2015 to make any additional contributions that you'd like to count towards your 2014 taxable income.

Tax-deferred growth on your money each year. Once you put some of your earnings into a SEP IRA, you decide where to invest it. Options include mutual funds, bonds, stocks, real estate investments and more. The money grows each year without being taxed. Taxes apply once you begin withdrawing the money at age 59 ½. If you withdraw the money early, you are subject to a penalty fee, similar to traditional IRAs.

Whether you work as a freelancer or run a small business with employees, a SEP IRA is something to consider if you're looking for a simple way to save money on taxes, invest in your future and attract qualified candidates.

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