Simplified Employee Pension (SEP) Plans are a fantastic tool for small business owners, and employees of small businesses, to save and invest for retirement. They are simple to manage, and they come with major tax advantages. In some ways, they are superior to employer 401k plans.
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What are SEP plans?
A Simplified Employee Pension (SEP) plan is a tax-advantaged way for business owners to contribute toward their employees’ retirement. Employees and employers contribute to an Individual Retirement Account or Annuity (IRA) set up for each plan participant (a SEP-IRA). SEP plans share many of the same characteristics as employer-administered 401k plans. But, they also have their unique characteristics and advantages.
A Simplified Employee Pension plan is a retirement savings plan that an employer can set up. It is a qualified retirement plan that meets certain IRS requirements and therefore offers several tax benefits. Small businesses often use SEP plans, because they are relatively easy to administer compared to other types of retirement plans.
You can actually set up an SEP plan for self employment income from a side gig. This is true even if you already contribute to your main-gig 401k or similar investment vehicle.
What are the benefits?
The main benefit of SEP plans is the tax treatment of contributions. Employees make contributions to the plan on a pre-tax basis, and the employer may also make contributions. This means that the employee may deduct contributions from their current year’s tax liability, lowering their tax bill for that year. The money in the plan grows tax-deferred. Employees can typically start taking distributions from the plan at age 59 1/2.
How do SEP plans differ from other retirement vehicles such as 401ks?
In many ways, SEP plans are similar to employer-managed 401k retirement plans. However, there are several key differences. First, SEP plans do not have the same employee participation requirements as 401k plans. With a 401k plan, employees must be allowed to contribute a certain percentage of their salary to participate in the plan. However, with a SEP plan, employees are not required to contribute to the plan to participate. Accordingly, SEP plans may be a good option for businesses that do not want to require employees to contribute.
Second, SEP plans have higher contribution limits than 401k plans. For 2022, the contribution limit for SEP plans is $61,000 (or 25% of total compensation, whichever is lower). The contribution limit for 401k plans is $20,500. So business owners and employees can contribute more to a SEP plan than they could to a 401k plan.
Finally, SEP plans are not subject to the same employee vesting requirements as 401k plans. With a 401k plan, employees must typically work at a company for a certain number of years before they are fully vested in the plan. However, with a SEP plan, employees are immediately vested in the plan. This means they will have full ownership of the account even if they leave the company.
How to set up an SEP plan for your small business
Setting up an SEP plan as a small business owner is relatively simple. You will need to choose a custodian for the plan, which is typically a bank, credit union, or brokerage firm. Then you will need to provide all eligible employees with information about the plan. You will also need to set up an SEP-IRA for each employee who will be participating in the plan. Each employee will be in control of their own SEP plan management.
Once the plan is set up, you will be able to make contributions to the SEP-IRA for each employee. You can choose to contribute a fixed percentage of each employee’s salary, or you can choose to contribute a fixed dollar amount for each employee.
One final note– you can actually set up an SEP plan for self employment income from a side gig. This is true even if you already contribute to your main-gig 401k or similar investment vehicle.
SEP plans are available at Luther Wealth Management
I can help manage an SEP plan for your small business at Luther Wealth. My custodian broker, Interactive Brokers, offers SEP IRAs as an account option, along with Roth and Traditional IRAs, brokerage accounts, and inherited IRAs. I’m happy to discuss this with you if you’d like to learn more.
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