The freedoms and advantages that come with being your own boss are undeniable. Nonetheless, self-employment has trade-offs, such as the lack of an employer-sponsored retirement plan. Many entrepreneurs feel like they’re missing out in the absence of an established 401(k).

The good news is that there’s a tax-advantaged retirement account that caters to the needs of self-employed individuals and small business owners – it’s called a SEP IRA. Not only can this account revolutionize your retirement plan, but it also functions as a valuable business tool.

What is a SEP IRA?

A SEP, or Simplified Employee Pension, IRA is a tax-advantaged retirement account that self-employed individuals and small business owners can utilize. It functions very similarly to a traditional IRA, and small business owners can offer the plan to qualified employees as a benefit.

How Does a SEP IRA Work?

A SEP IRA shares many of the same characteristics as a traditional IRA. Contributions are tax-deductible the year they are made, and earnings grow tax-deferred until withdrawn during retirement. A significant difference, however, is how much money you can contribute annually to a SEP IRA.

• Contribution Limits

In 2023, the contribution limit for a traditional IRA is $6,500. With SEP IRAs, the ceiling is considerably higher – $66,000 for 2023. However, this figure cannot exceed 25% of an employee’s annual compensation.

• Employee Factor

SEP IRAs are more popular among the self-employed than with small businesses because of contribution rules. If you’re a small business owner, whatever percentage of your compensation you contribute to your SEP IRA, you must also contribute to eligible employees’ SEP IRAs.

For example, you decide to contribute 10% of your compensation to your SEP IRA for the year. As the employer, you must also contribute 10% of each employee’s salary to their SEP IRAs. This can become costly for small businesses unless they have very few staff.

Who is Eligible for a SEP IRA?

Any self-employed individual or small business owner can establish a SEP IRA. If you want to offer a SEP IRA as a benefit to your employees, they will need to meet the following criteria:

• Must be 21 years of age or older.

• Must be employed at your business for three of the last five years.

• Must receive at least $750 in compensation in 2023 (this figure can change annually with regular tax law updates).

Benefits of a SEP IRA:

In addition to being a powerful retirement savings tool, SEP IRAs can also bring significant benefits to your business. Accountholders receive the following perks:

• High contribution limits up to 25% of your annual compensation (a maximum of $66,000 in 2023).

• Contributions are tax-deductible in the calendar year they are made. That means you can enjoy a lower tax bill on years when your business performs well.

• Earnings grow tax-deferred until they are withdrawn in retirement.

• You may begin withdrawing funds at the age of 59 ½ years.

• SEP IRAs are easy to set up and maintain.

• You can change your contribution level every year. If your business has a good year, you can contribute more to offset a larger tax bill.

• Self-employed individuals and small business owners can contribute to a SEP IRA and also maintain a personal traditional or Roth IRA.

Drawbacks of a SEP IRA:

While SEP IRAs offer a slew of perks, especially for self-employed people, there are some trade-offs.

• Tax benefits are received the year funds are contributed. There is no Roth IRA version with tax benefits in retirement.

• If you withdraw funds from your SEP IRA before age 59 ½, you must pay taxes on the amount withdrawn and a 10% penalty.

• Contributions must be the same for all employees (including yourself) in a particular year. Again, SEP IRAs are more popular among those self-employed and small business owners with very few or no employees.

Other Considerations:

The higher contribution limit of a SEP IRA differentiates it from both traditional and Roth IRAs. This feature also allows it to play a significant role in your business’ finances and strategic planning. For example, if you have an outstanding year, you could increase your contributions to offset a higher tax bill.

It’s also worth noting that you are not limited to only a SEP IRA. As a small business owner or self-employed individual, you can have a SEP IRA. Then, you can also contribute to a traditional or Roth IRA as part of your personal retirement plan.

We’re Here to Help!

When it comes to retirement planning, everyone is different. If you’re self-employed or own a small business, a SEP IRA might be the perfect tool to help boost your retirement savings and offset taxes.

If you’re interested in learning more about investment opportunities or retirement planning, we’re ready to help. Please stop by any of our convenient branch locations or call 540-389-0244 (local) / 866-389-0244 (toll-free) to speak with a team member today.

Each individual’s financial situation is unique and readers are encouraged to contact the Credit Union when seeking financial advice on the products and services discussed. This article is for educational purposes only; the authors assume no legal responsibility for the completeness or accuracy of the contents.