What Is a SEP-IRA?

From setting your own hours, to doing work that’s meaningful to you, there’s no denying the perks of being self-employed. But as your own boss, you’re also on the hook for many of the benefits that people who work for a company receive from their employer, including health care, life insurance and disability insurance — not to mention your paycheck. And without a company-sponsored 401(k) match, you’re on your own for saving for retirement as well. Luckily you have a few options, including a Simplified Employee Pension (SEP)-IRA. Here’s what to know about them. 

WHAT IS A SEP-IRA AND WHO IS ELIGIBLE? 

If you’re self-employed, a SEP-IRA allows you to save for your own retirement. But before opening a SEP-IRA account, you first need to establish a SEP plan, which any size business can do. Once you have your SEP in place, then you can create a SEP-IRA account.

If you’re a small business owner, you can also create SEP-IRAs for your employees. To participate in a SEP plan, an employee must: 

• Be at least 21 years old 

• Have worked for the company during three of the last five years 

• Have earned at least $650 in compensation during the year 

WHO CAN CONTRIBUTE? 

As the owner of the SEP plan, you are responsible for funding your individual SEP-IRA. And if you have employees, you must set up and fund a SEP-IRA for each one who is eligible — employees themselves cannot contribute to their own SEP-IRA. In addition, you must contribute the same percentage of compensation for everyone in your company who has a SEP-IRA, including you. That means you can’t fund your account with 25 percent of your net earnings and contribute 10 percent to your employees’ accounts.

HOW MUCH CAN EMPLOYERS CONTRIBUTE TO AN EMPLOYEE’S SEP-IRA? 

While a SEP-IRA follows the same investment, distribution and rollover rules as a traditional IRA (meaning the contributions are made pre-tax), the difference is how much you can contribute. In 2021, you can contribute $58,000 or 25 percent of your pay to a SEP-IRA — whichever is less.

WHAT ARE THE BENEFITS? 

In addition to being a way to spearhead your own retirement if you’re self-employed, a SEP-IRA can be a simple way to offer retirement benefits to yourself and your employees. A SEP plan is easy to set up, and with low administrative fees, it’s inexpensive to maintain. Your business will not pay any taxes on the investment earnings, and any contributions you make on behalf of yourself and your employees are tax deductible.

Another advantage of a SEP plan is the flexibility. Each year, you can decide not only if you’re going to contribute to the SEP-IRAs, but also how much. This can be helpful if your business faces a cash flow issue, or if you have an exceptionally strong year and want to increase your contributions. Just remember that when you do decide to make contributions, you must do so equally for all eligible employees. A financial advisor can help you determine what’s right for your situation. 

Withdrawals are subject to income tax and may be subject to a 10 percent IRS early withdrawal penalty if taken before age 59 1/2.