Posted by The TaxAdvocate Group, LLC

SEP IRA - How do they work

SEP IRA - How do they work

SEP IRA is an employer-sponsored pension plan that allows business owners with 0 to 5 employees to earn a high income. The SEP will enable employers and the self-employed to pay $ 56,000 or 25% of their taxable income annually, $ 50,000 more than traditional IRAs. To use the SEP, employers must make proportionate contributions to all full-time employees.

Mandatory contributions to the SEP can be costly. If you have more than five full-time employees, a 401 (k) plan will provide more flexibility, allowing a contribution of $ 56,000. The Spark 401k offers traditional business plans, private retirement plans and 401 (k) individual plans that are easy to set up and cost up to 66% below the industry average. Start with Spark 401k and a 401 (k) consultant will help you choose the right program for you and your business.

What is an IRA?

An IRA is an investment account with tax benefits that allow you to reserve up to $ 6,000 ($ 7,000 if you have more than 50) each year to save for retirement. Anyone with income has the right to use one and can open an IRA with almost any investment consultant (including Ellevest).

What is a SEP IRA and why should I want one?

This is the "Individual Pension Retirement Account for Employees," which is five times faster. A SEP IRA looks a lot like a personal IRA, but with some problems. The important thing is that your employer (which can be you if you own the business) pays all the contributions.

But here is the best part (also important): a SEP IRA has very high contribution limits. By 2019, up to 25% of income or $ 56,000, whichever is less. This limit eliminates a typical water IRA and is much higher than the 401 (k) sponsor (which limits it to $ 19,000 or $ 25,000 if you are over 50).

How does a SEP IRA work?

Individual retirement accounts (IRAs) are pension accounts used by self-employed individuals and by companies with fewer than 401 employees. This is because the 401 (k) s, while advantageous, have higher costs and require more management than a traditional IRA, so they are only suitable for businesses with more than one employee.

However, the amount of contributions you can pay is limited. Currently, it is possible to deduct only $ 6,000 per year of taxable income. This is well below the total annual contributions of 401 (k), which can reach USD 56,000 (USD 62,000 with revaluation contributions) if carryovers, allocation and benefit sharing are maximized.

To avoid this problem, SEP IRAs have been created. These retirement accounts allow small business owners to contribute up to $ 56,000 a year, just like the traditional 401 (k), but at a much lower cost, making it an ideal retirement option for workers or families — small businesses where a 401 (k) does not make sense. However, to be eligible, you must enter a proportional salary percentage for all full-time employee accounts.

This highlights some issues with IRA SEP. Although no minimum or a maximum number of employees is required, the mandatory contributions make the operational programs not applicable to companies with more than 5 to 8 employees. Indeed, the cost of funding employee contributions at this level becomes more expensive than the combined cost of the 401 (k) administration and any 401 (k) employee comparisons (which is not necessary).

Also, only employers can establish or contribute, including employee contributions. Unless a person owns a business of any size, you cannot use a SEP IRA.

Who can participate in a SEP plan?

According to Internal Revenue Service (IRS) Rule 2018, a person must be at least 21 years old, have worked for the employer for at least three of the last five years, and receive a minimum remuneration of $ 600 from the employer during the current year to qualify for a SEP IRA. Individual employers may be less restrictive in terms of qualification requirements for their specific IRA SEP plans but may not be more definitive than the IRS rules.

The employer may omit certain types of employees from participating in a SEP IRA even though they qualify under the plan rules. For example, workers subject to an association agreement excluding pension offers. Foreign workers can also be excluded if they do not receive US wages from the employer. 

Not all companies can use SEP IRA, which was created primarily to encourage retirements among companies that would otherwise not have employer-sponsored plans in place. Sole proprietorships, partnerships, and businesses can establish SEPs.

How can I open a SEP IRA?

First, the employer (you, if you are the owner) defines the SEP plan. This means creating a formal written agreement that is usually based on the government model because it is uncomplicated and does not need the approval of the IRS. If your company can not use the template due to special circumstances, some financial institutions have government approved prototypes that can be used. And if you have specific needs for your business that are not covered by an existing prototype, you can create your custom contract. All you have to do is know that the last option will require you to get special approval from the IRS.

So, if you are the only employee of the company, you can open a SEP IRA with an investment consultant and start making contributions. You can choose the actual investments in IRA SEP, as you do for a personal IRA.

If you have other employees, the next step will be to give all of your staff a copy of the plan and make sure everyone opens a regular IRA for you and chooses your investments.

Here are some cases where a SEP IRA may be particularly appropriate:

Independent consultants

The ideal candidate for a SEP is the owner of a high-income business that expects to collect a high-income tax with no administrative fee of 401 (k). They have no employees for whom they need significant contributions, or there may be 1099 contracts, which are not entitled to the 401 (k) of their employer. By using a SEP, the owner of a single company can contribute much more than would be possible in a traditional IRA, avoiding the unnecessary cost of managing a 401 (k) only for them.

Small businesses

These companies usually have five employees or less. They have essential benefits that are not always consistent. Contributions to IRA SEP are discretionary so that they can be reduced or omitted in difficult times and are deductible for the entrepreneur. Business proprietors can use SEP to reward employees with non-taxable profits until retirement. This is because, since it is necessary to make mandatory contributions to full-time employees, any business with more than five employees can find a non-economic SEP IRA. Instead, this could be the size at which a fully managed 401 (k) plan is a better option for its employees.


In some areas, it is common to use multiple LLCs with different functions. In the real estate sector, there may be different limited liability companies to maintain and manage the property or to manage the accounting. Some limited liability companies may have employees, while others have only one or two members and no employees. Homeowners may use these strictly controlled limited liability companies to allocate IRA SEP's revenues without providing funds to employees of other potentially related companies.

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