What Is a SEP IRA?

Estimated reading time: 2 minutes(Last Updated On: April 13, 2021)

A SEP IRA is a retirement fund made for people who are self-employed and people who own businesses. SEP stands for Simplified Employee Pension and IRA stands for individual retirement accounts. It is a really basic account for retirement, just like traditional IRA. Contributions made to these accounts are tax deductible, and until retirement, investments are tax-deferred until a person has reached retirement. At that point, distributions are taxed as income.

Who is it best for?

When considering if it’s good for you, it is important to consider if you currently have employees who the IRS would consider eligible to be participants, you must make contributions on their behalf, and the contribution should be an equal compensation to yours. Participants who are eligible are 21 years or older, have worked for you for three years out of five, and in the past year, have earned $600 from you within the past year. Because there is a rule that requires equal compensation of contributions, SEP IRAs are usually best for people who are self-employed, or people who own small businesses but have few employees.

Are there contribution limits, and if so, what are they?

The limits are what make SEP IRAs stand apart from traditional IRAs. For a self-employed individual, contributions are limited to 25% of your net earnings from self-employment (not including contributions for yourself), up to $58,000 (for 2021; $57,000 for 2020). Employers contributions don’t reduce the contribution you can make to an IRA, but your traditional IRA contribution can be reduced when you’ve reached higher income levels when you combine both plans, if you are an employee that gets covered by them.

How Can I Open an Account?

The process for opening an account is very similar to the process of opening a traditional IRA. A good number of people who provide IRA accounts also offer SEP IRAs, and the account can be opened online.

The steps are as follows:

    1. Make a written agreement. This can be done with an IRS form, or it can be done through the company that provides the account.
    1. Make sure eligible employees are informed about the SEP IRA. Information can be obtained through the account provider, or they can be given a copy of IRS Form 5305-SEP.
  1. Each eligible employee must have a separate SEP IRA account, so it’s important to set that up with the employee provider.

How Do I Invest my SEP IRA?

Understanding that a SEP IRA is not an actual investment is super important. You can choose from offered investments once the account has been opened. Options usually include mutual funds, stocks, and bonds. The less time there is towards retirement, the more important bond funds will become. You can also look into index funds for bonds.

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