Many high-income self employed professionals such as doctors and lawyers are often faced with the problem of saving enough for retirement. Because of their high income, many of these professionals would like a retirement savings plan that would allow them to contribute significantly more than the $6,000 or so allowed by traditional IRAs but would not like to set up a 401k plan because of the cumbersome reporting requirements that are often associated with those plans. An SEP IRA retirement plan is a great solution to this problem. Unlike a traditional IRA, contributions to an SEP IRA can be up to 25% of income but no more than $66,000 in 2023 (or $61,000 in 2022). Unlike a 401k plan, there are no annual reporting requirements and setting up an SEP Plan is relatively simple. The financial institution that holds the plan’s SEP-IRAs handles most of the paperwork necessary.
Who sets up an SEP? An SEP is set up by the employer and all contributions are made by the employer to each employee’s SEP-IRA. The employees are always 100% vested.
How is an SEP set up? The employer, or the self-employed, must execute a formal written agreement to provide benefits to all eligible employees. The employer must provide each eligible employee specific information about the SEP and then establish a separate SEP-IRA for each employee.
When can an SEP be setup? An SEP can be setup at anytime. But since all contributions to the SEP are done by the employer and since these contributions are tax deductible, an SEP can be set up by the time the tax return is due for the year you want to take the deduction for.
Who is eligible to participate? Generally, any employee who performs services for your business must be included in a SEP. However, there are some exceptions to this general rule. The employees that you may exclude from an SEP are those who:
- Have not worked for the company during three out of the last five years.
- Have not reached age 21 during the year for which contributions are made.
- Employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees’ union and you.
- Nonresident alien employees who have received no U.S. source wages, salaries, or other personal services compensation from you.
- Received less than $750 in compensation in 2023 (subject to cost-of-living adjustments in future years) during the year.
Do I have to make a contribution to the SEP every year? No. You (the employer) can choose when to contribute. So you contribute to the SEP in one year and then skip the next year. But if you chose to contribute in one year, then you must make contributions to all eligible employees.
Can an SEP be later rolled over to another retirement plan? Yes. The employer or the employee can later choose to rollover the SEP into a traditional IRA, Safe harbor 401(k), 403(b) plan, Governmental 457 plan or a plan qualified under Code section 401(a). There are some restrictions on rollovers to a Roth IRA.
Withdrawals from an SEP
SEP contributions and earnings can be withdrawn at any time. A withdrawal is taxable in the year received. If an employee makes a withdrawal before he or she is age 59½, generally a 10% additional tax applies. SEP contributions and earnings may be rolled over tax free to other IRAs and retirement plans. SEP contributions and earnings must eventually be distributed. A specific minimum amount is required to be distributed by April 1 of the year following the year you reach age 70½. Penalty-free withdrawals permitted before age 59 1/2 for first-time home purchase up to $10,000, higher education expenses or in event of disability or death.
Are there any investment restrictions on SEP IRAs? SEP IRAs can be invested in stocks, bonds, or Mutual Funds. Depending on the trustee of your IRA, you may be allowed to invest in real estate. The IRS does impose a restriction on investment in collectibles and will consider any such investment as a distribution and will impose a 10% penalty if it’s considered an early distribution.
