Traditional Individual Retirement Accounts, or IRAs, are not the only type of IRA that is available. There are IRAs that are established by individuals and those that are employer-sponsored. Employer-sponsored IRAs include matching contributions. A SEP IRA is one specific kind of IRA that is perfect for small business owners, as an alternative to the standard profit sharing plan for employee retirement.
The benefits of an SEP IRA
SEP stands for “Simplified Employee Pension.” This is how it works. Unlike employer-sponsored IRAs, the employer deposits cash contributions into the IRA account for the employee, instead of into an employer trust account.
SEP IRAs make accounting simpler because they do not require a complicated written legal document. Nor do SEP IRAs have as many requirements with regard to compliance reports and other disclosures as other plans do. Also, an SEP IRA has very minimal administrative fees.
Some Advantages of SEP IRAs
There are several tax benefits available when you select SEP IRAs. Contributions to an SEP IRA are tax deductible for the employer, and the earnings are tax deferred for the employee. SEP IRAs provide more flexible contribution rules. Another benefit is that employers can make annual discretionary contributions to an employee’s SEP IRA, of up to 25% of the employee’s compensation.
SEP IRAs can be established at any point, up until the tax filing deadline, with extensions, which is different from profit sharing plans and other pensions. It also makes tax planning an investment quite flexible.
Establishing your SEP IRA
The most common types of business that choose to use SEP plans are sole proprietorships, partnerships, corporations and some tax-exempt organizations. The employer executes an SEP plan document provided by the SEP IRA custodian. Next, each eligible employee opens a separate SEP IRA account at the institution of his or her choice. The employer can make contributions on behalf of the employee to that account.
Rules regarding contributions and participant eligibility
Although an SEP IRA is funded by the employer, it is considered to be 100% vested in the employee at all times. This year, the contribution limit for an SEP is the lesser of either 25% of the employee’s compensation or $53,000.
To be eligible for participation in an SEP IRA, the employee must be at least 21 years of age and have worked for the company in any three years within the prior five-year period. This applies to both full-time and part-time employees. An employer can choose to have a less restrictive age or service requirement, as long as the rules of eligibility are applied consistently to every employee, including owners who are employed as well.
If you have questions regarding SEP IRAs, or any other retirement planning needs, please contact the Schomer Law Group either online or by calling us at (310) 337-7696.