The simplified employee pension individual retirement account (SEP IRA) is a good option for small business owners who want to offer this benefit to their employees. The employer also may open a SEP and contribute to their own retirement account.
As the name implies, setting up and managing a SEP IRA is streamlined compared to the processes for other qualified retirement plans that are used mostly by big corporations, such as the 401(k).
- Employers must contribute to a SEP IRA by the tax-filing deadline, April 15, or by the extension, Oct. 15, if there is one.
- Only employers may contribute to a SEP IRA, not employees.
- The maximum contribution to a SEP IRA is $57,000 in 2020, up from $56,000 in 2019—much higher than the limits for other types of employer-sponsored qualified plans.
Notably, the contributions to a SEP IRA are made entirely by the employer, who can select an IRA or an annuity plan. Employees may, if they wish, open their own IRA accounts and contribute up to the annual Internal Revenue Service (IRS) limits.
Contributions must be made by the tax-filing deadline for the year in which they are made. Here is a closer look at SEP IRAs, how contributions work, and when they are due.
Contribution Deadline for SEP IRAs
Employer contributions to a SEP IRA are made in tax-deductible dollars. Business owners, including the self-employed, can also open a SEP IRA account and contribute to their own retirement savings.
In either case, the deadline is the same. Contributions must be deposited into every employee's SEP IRA account by that year's tax-filing deadline, which is typically April 15 of the following year.
If, however, the employer has filed an extension, then the final SEP IRA contribution date is the extension deadline, which is usually Oct.15.
Say John earns $50,000 a year at XYZ Corp. The company wants to contribute 15% of each employee's compensation to their SEP IRA accounts in 2019. This means that John will receive a $7,500 contribution to his SEP IRA for 2019. XYZ Corp. has until April 15, 2020, to make the contribution to the employee SEP IRA accounts. If XYZ has filed a tax-filing extension until Oct.15, 2020, then the contributions must be made for John and all other employees by that date.
SEP IRA Contribution Limits
One of the advantages of a SEP IRA is that it has much higher contribution limits than a traditional or Roth IRA. In both 2019 and 2020, the annual contribution limit for a traditional or Roth IRA is $6,000, plus $1,000 for those aged 50 or older.
With a SEP IRA, in 2020 an employer can contribute as much as 25% of an employee's gross annual salary or $57,000, whichever is less; that's up from a limit of $56,000 in 2019. Self-employed business owners can contribute 20% of their net adjusted self-employment annual income, as long as the contributions do not exceed $57,000.
With a SEP IRA, employers may change their contribution levels from year to year based on business considerations.
With a traditional IRA, employers may match a percentage of the employee's contribution. But in the SEP IRA, the contribution is entirely up to the employer and can change from year to year.
In effect, this makes it a kind of profit-sharing plan. When business is great, the employer may make a generous contribution, as much as 25% of each employee's salary. When business is bad, the employer may reduce or eliminate the company contribution.
This is not a bonus plan, though. If an employer has a SEP IRA, an identical percentage of salary must be deposited for each eligible employee.