The simplified employee pension individual retirement account (SEP IRA) is a cost-effective option for small business owners who want to offer retirement benefits to their employees. The employer may also contribute to their own SEP account.
As the name implies, setting up and managing a SEP IRA is streamlined compared to procedures for establishing and maintaining other qualified retirement plans used mostly by big corporations, such as the 401(k).
- In a typical year, employers must contribute to a SEP IRA by the tax-filing deadline, which is April 15.
- For 2020, the filing deadline is July 15.
- The maximum contribution to a SEP IRA is $57,000 in 2020, up from $56,000 in 2019.
Notably, contributions to a SEP IRA are made entirely by the employer. Employees, however, may open their own Individual Retirement Account (IRA) and contribute up to the annual limits.
SEP contributions must be made by the tax-filing deadline for the year in which they are made. Note: for 2020 this deadline has been extended to July 15.
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 the employer has filed an extension, then the final SEP IRA contribution date is the extension deadline, which is usually October 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. In a normal year, XYZ Corp. would have until April 15 the following year to make the contribution to the employee SEP IRA accounts. If XYZ has filed a tax-filing extension until October 15, 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. To determine their annual limits, self-employed business owners must make a special computation that factors in the deductible portion of their self-employment tax.
With a SEP IRA, employers may change their contribution levels from year to year based on business considerations.
With a 401(k), 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.