For self-employed individuals and business owners (including sole proprietors), understanding the SEP IRA rules ensures everyone can maximize their IRA account. Get the basics here.
In this article:
- What Is SEP IRA?
- The Basic SEP IRA Rules
- When to Exclude Employees
- SEP IRA Contribution Limits
- How Different Is It from Other IRAs?
SEP IRA Rules | Maximizing Employee and Employer Contributions
What Is SEP IRA?
For those who do not know much about SEP IRA, it is best to define it first before proceeding to the SEP IRA rules.
“SEP” stands for “self-employed person” while IRA means individual retirement account. In other words, SEP is just one of the many different types of IRAs out there.
It is intended for both employees and their employers. The latter may include those who earn self-employment income whether they have their own employees or not.
A holder may use the SEP contributions in the same fashion as with other IRAs. It means they can invest in different types of portfolios such as mutual funds, stocks, and bonds. There are no administration costs involved for self-employed persons who have no employees, but for the self-employed person with employees, all employees should receive the similar benefits in a SEP plan.
The Basic SEP IRA Rules
There are at least three important SEP IRA rules to remember:
- The participant needs to be at least 21 years old.
- They must have been an employee by your business during any 3 of the previous 5 years (the 3 of 5 rule).
- Their compensation within the tax year is least $600 (2016-2018).
You may elect to include them for less restrictive reasons if you choose to do so for your business. For example, it is possible to extend an employer-sponsored retirement plan to those who are younger, say, 18 years old. However, the eligibility requirements must be identical for all employees who participate, including business owners.
The three of five rule applies to any duration of employment within that timeframe according to your plan calendar. Most plan calendars coincide with calendar years, but that is not necessarily the case.
If you hired someone the day after Christmas in 2014 and they worked through 2015 and the employee’s last day was January 8, 2016, then your employee must be eligible for participation in your SEP plan, provided they meet the other requirements for age and income. Even if that employee left during 2015 and came back, they would still be eligible as long as they met the other criteria.
Aside from the basic SEP IRA rules, you have a great deal of flexibility when it comes to defining employee eligibility requirements, but do not forget these standards also apply to you.
When to Exclude Employees
If the SEP IRA rules define who can qualify, they also tell you who among your employees may not participate in the plan.
You may elect to exclude some employees from SEP contributions, including:
- Employees covered by union agreements you and the union bargained for in good faith
- Those who are non-resident aliens who do not earn US-source compensation.
- Employees who do not meet the minimum requirements required by law or your organization’s rules for participation
On the other hand, employers may choose to create SEP IRAs for employees entitled to participate in your company’s plan even if they are not able or willing to do so on their own.
You can learn more about SEP IRA by reading this guide.
SEP IRA Contribution Limits
The SEP IRA rules also cover contribution limits. These dictate how much an employer or employee may deposit into the IRA.
There are very specific SEP IRA limits for employers to follow. For instance, SEP IRA contributions cannot exceed 25% of compensation or $55,000, whichever is lesser (in 2018 and subject to cost-of-living adjustments in subsequent years). Additionally, this maximum contribution is for all contribution plans, including SEP IRAs. You must contribute the same percentage of salary for all eligible employees and yourself.
The SEP IRA rules on contributions and limits are slightly different for people who are self-employed. Working with a highly trained accountant or a financial advisor can help you create an effective SEP IRA and other plans to fund your retirement.
How Different Is It from Other IRAs?
SEP IRAs work similarly as a Traditional IRA (some, though, also invest in personal Roth IRA to maximize their strategy). By the time the employee reaches 70.5 years old, it is already mandatory to make the withdrawals. However, you can withdraw anytime, although there may be an additional tax if you do so before the age reaches 59.5 years old. Withdrawals are also subject to tax as ordinary income.
If you contribute to your SEP IRA, the funds you contribute to your SEP IRA will count toward your IRA contribution limits for the year, reducing the amount you are eligible to contribute to other IRAs, including your Roth IRA.
Employer-funded SEP IRAs do not allow for catch-up contributions unless you are permitted to make Traditional IRA contributions to your SEP IRA.
Do you need more help in understanding the SEP IRA rules or in creating a retirement plan for your employees and yourself? It may be worth your while to consider working with IRA experts. BirchGold seeks to provide you with the proper guidance to help you achieve your short and- long-term financial goals, including adequate retirement planning. Contact us today to learn more about your options. We will work to show you how you can make your SEP IRA plan work for you and your employees with maximum results.
What are your top questions regarding SEP IRA rules? Share your thoughts in the comments section below.