A simplified employee pension individual retirement account, usually referred to as a SEP IRA, is generally used by a business owner for retirement benefits. The SEP IRA contribution limits dictate how much an employer or employee may deposit into the IRA. Funds deposited into the SEP IRA may be invested just as they are in most other IRAs. Setting up a SEP IRA is easier than other plans and is also less costly than other types of retirement accounts.
IRA Contribution Limits You Must Know About
Employee Eligibility and Deadlines
Some of the restrictions that employers could place on employees include:
- The employee must be 21 years of age;
- The employee must have worked for the employer for three of the last five years; and
- the employee must have earned at least $600 for the tax year.
The deadline for an employee to establish a SEP IRA is the employer’s tax filing deadline, which also includes extensions. Once a qualified withdrawal has been taken after a member turns 59 ½ years old, the funds are taxed as ordinary income.
Benefits of a SEP IRA
An employer may set up a SEP IRA for themselves alone, or with his or her employees as well. One of the major benefits of setting up a SEP IRA is that it does not have any of the starting and operating costs that you must pay if you start a conventional retirement plan.
Any contributions to the SEP IRA are tax-deductible, which means the business does not pay taxes on any funds deposited into SEP IRA accounts. Furthermore, an employer is not forced to make contributions every year. Nor does the SEP require a specific amount to keep it active.
In some cases, the employer may be eligible for a tax credit of up to $500 per year for the first three years to cover the cost of starting the plan. This credit is 50 percent of the cost to set up the plan and to administer it. It also covers some of the cost for educating your employees about the plan.
In order to receive the tax credit, certain restrictions apply:
- You must have fewer than 100 employees who received a minimum of $5,000 from you during the prior year.
- At least one of the participants (employees) has to be a non-highly compensated employee.
- In most cases, you may not receive a tax credit:
- if you have the same employees you made contributions to under another plan when they worked for you
- if the control group included you (the employer)
- if employees worked for your predecessor
The tax credit may be carried to other tax years if you are not able to use it in the current year.
And, other administrative costs are low, thus making this plan affordable for employers.
SEP IRA Contribution Limits
A SEP IRA does have contribution limits. The most an employer may contribute is 25 percent of each employee’s pay. Additional limits include:
- Self-employed people may contribute on 18.587045 percent of their net profit adjusted for the self-employment tax deduction.
- The contributions may not be more than the lower of these amounts:
- 1.25 percent of the employee’s pay or
- $55,000 for 2018 or $54,000 for 2017
- Catch up contributions and elective salary deferrals are not allowed in SEP plans.
If you did end up contributing more than the annual limits, you must correct the mistake.
Retirement Savings Contributions Credit
You may also be eligible for a retirement savings contributions credit for up to $2,000. Your accountant will be able to figure the credit for you. If you do your own taxes, review Form 8880 and its instructions to learn if you are eligible for the credit and to learn how to figure how much credit you are entitled to.
In a Nutshell
The SEP agreement allows you to directly contribute to the retirement plan and is easier than setting up a money purchase plan with a trust or a profit-sharing plan. Once employees become eligible, you are able to set up a SEP IRA for them and you will also benefit from tax credits for contributions. When planning a SEP IRA, keep the yearly contribution limits in mind to avoid the hassles of fixing the mistake.
Did this article enlighten you on your SEP IRA contribution limits? Let us know in the comments section below.