SEP IRAs: A Complete Guide

Just over 1 in 10 of self-employed individuals in a single-person business is currently contributing to a workplace retirement plan. That’s a staggering statistic given that there are currently nearly 10 million Americans who identify as self-employed.

However, it’s somewhat understandable given the fact that most people who work as employees for larger companies are often immediately enrolled in a retirement plan via the business they’re working for; self-employed individuals who work for themselves don’t have that option. And, when you’re running the whole show yourself there’s little time to research your retirement account options, right?

We get it. That’s why we’re here to help. As a self-employed worker, you’ve got options. Namely, SEP IRAs are one of the easiest retirement accounts to set up as an individual. Here’s a complete guide to understanding SEP IRAs and your retirement account options as self-employed.

Wanna skip the talk and go straight to opening your own brokerage account? Download the Wealth Stack app today to get started.

What is a SEP IRA?

SEP stands for Simplified Employee Pension. A SEP IRA is a type of Individual Retirement Account (hence the name IRA), that allows individuals like you to set aside up to 25% of their income for retirement before taxes are taken out.

SEP IRAs were designed by the government to encourage small business owners and self-employed workers to save for their retirement without incurring large fees and other expenses. These types of ccounts allow the funds to grow tax-deferred until they are withdrawn, making them a very attractive vehicle for retirement savings.

However, do keep in mind that this does mean that you’ll be taxed at whatever tax rate you’re currently at when you reach retirement. Keep that in mind if you plan on scaling quite a bit in your business or solo career.

What Are the SEP IRA Contribution Limits?

The contribution limits for a SEP IRA are a bit more complicated than they might be for something like a traditional 401(k) (you can find those contribution limits for 2021 here). 

Here’s what the IRS says about SEP IRA contribution limits:

Contributions an employer can make to an employee's SEP-IRA cannot exceed the lesser of:

  1. 25% of the employee's compensation, or
  2. $58,000 for 2021

So, as a self-employed individual, contributions are limited to 25% of your net earnings from self-employment, up to $58,000. This means that if 25% of your net earnings from whatever you do as self-employed exceeds $58,000 (for 2021; be sure to check the current limit for future years), you’re not able to contribute more than that.

As the IRS states here, “Fnet earnings from self-employment are your gross income from your trade or business minus allowable business deductions.”

What’s cool about a SEP IRA as a freelancer, though, is that contributions are tax-deductible. This is similar to the benefits of contributing to a regular IRA in that it helps you lower your tax  burden each year. Instead of paying those taxes, simply contribute to your SEP IRA and save the money for your future self.

Who Can Open a SEP IRA?

Do you have to be a small business owner to set up a SEP IRA for yourself? Not technically. However, SEP IRAs are great for self-employed individuals or small business owners who have one or more employees.

What about who can contribute to a SEP IRA? SEP IRA contributions are based on the individual's salary, not that of a company. This means that SEP IRA contributions can be made by self-employed individuals and small business owners with no more than 25 full-time employees. As well, SEP IRA plans can be established by small business corporations and partnerships, including LLCs. 

SEP IRA rules allow you to have several SEP IRA accounts, but the maximum allowable contribution is the same for all SEP IRAs held at a particular time. This means that, for example, if the SEP IRA contribution limit for 2021 is $58,000 (which it is), and you have three SEP IRA accounts, you can only contribute a total of $58,000 across all of the three combined.

How to Open & Manage a SEP IRA

SEP IRA accounts are easy to set up and administer. On top of that, account holders have complete freedom to decide how their SEP IRA contributions are invested, which is pretty cool. Who administers these accounts? A SEP IRA trustee who is responsible for withholding employee contributions from their paychecks. They'll then forward the SEP IRA contribution to an investment company chosen by the SEP IRA holder.

In terms of contributions and personal management, it’s important to understand one thing if you’re the business owner. If you’ve set up a SEP IRA for your employees, they must be at least 21 years old and have worked for you in three of the last five years to qualify. And, they must have received at least $600 in compensation during the previous year.

Now, here’s the important thing. As the business owner, you don't have to contribute every year. However, if you do decide to contribute to your own account, you must also contribute to the account of every one of your eligible employees.

And, furthermore, if you make a 20% contribution to your own account, you have to contribute that same percentage to the account of every employee you have enrolled as well.

What if you’re the employee? Nothing to worry about! Only employers can contribute to a SEP IRA.

The Benefits of a SEP IRA

There are numerous benefits of contributing to a SEP IRA, especially if you don't have any other formal retirement account options such as a 401(k) because you don't work for a company. Some of the main benefits of a SEP IRA include the following:

  • These accounts offer an easy and inexpensive way to start saving for retirement.
  • You make SEP IRA contributions pre-tax, which lowers your taxable income.
  • You can change the amount you put away every year depending on your current financial situation.
  • With a SEP IRA, you don't have to file a SEP IRA contribution form with the federal government.
  • SEP IRAs help to protect your retirement savings against creditors because they are not subject to seizure by creditors.

The tax deferments is perhaps one of the biggest benefits, not just for a SEP IRA but for other types of retirement accounts as well. Likewise, when you’re contributing to a retirement account, you’re benefiting from compound interest. Read more on that here.

Start Investing in Your Future

As a solo business owner or self-employed individual, you’ve got lots of choices when it comes to planning and saving for your retirement. SEP IRAs are just one way to invest in your future.

If you’d like to start investing in yourself via stocks and other assets, download Wealth Stack. In the app you’ll find lots of free financial video courses that will help you learn the basics of investing as well as the advanced stuff. When you’re ready to invest, start investing straight in the app and watch your savings grow.

Download Wealth Stack here to start.