A SEP IRA plan can be established by a business owner with employees. A SEP IRA is funded 100% by the employer, employees do not contribute.
When a SEP IRA is established each eligible employee would open their own separate SEP IRA account. Annually the employer would make a contribution to their own SEP IRA account and to each eligible employee's SEP IRA account. The percentage contributed into each SEP IRA account is the same percentage for the employer and each eligible employee. The annual contribution percentage made by the employer is flexible and can be changed from year to year depending on profitability.
In general, contributions to the owner's SEP IRA account and the contributions made to each eligible employee's SEP IRA account are 100% tax deductible as a business expense. A SEP IRA allows generous contribution limits but also requires generous contributions from the employer on behalf of all eligible employees.
Who is considered to be an eligible employee?
Generally, when a SEP IRA is established IRS Form 5305 is completed. This short form sets the eligibility requirements for determining who is eligible such as age and length of employment. This form should be kept on file by the employer. When the employer and employees meet the eligibility requirements stated on the completed 5305 form then the employer must make contributions on their behalf. Employers must satisfy the same requirements as the employees. Employers can make the eligibility requirements less strict, but must make contributions to employees if they meet the following 3 requirements:
- 21+ years old
- Have at least 3 years of service in last 5 years
- Received at least $750 in compensation for 2023 ($650 in compensation for 2022).
SEP IRA Eligibility
Incorporated and unincorporated businesses. Sole proprietors, partnerships, LLCs, Subchapter S and C corporations qualify.
Must part time and seasonal employees be included in the SEP IRA?
Yes, if they earned $650 or more and worked for the business in 3 of the past 5 years and they are age 21 or older. Non-resident aliens may be excluded. When a SEP IRA is established a short form called IRS Form 5305 is completed which states the eligibility requirements. The requirements can be less restrictive than the above stipulations, but can't be more restrictive.
In what situations might a SEP IRA be appropriate?
A SEP IRA may be a good option for employers who want to make high contributions to their own SEP account and the SEP accounts of partners or employees.
Why would an employer with employees choose the SEP IRA?
An employer might choose the SEP IRA to be generous to employees and create loyalty and lower turnover. It also might serve as a motivating factor for employees because annual contributions are flexible at the employers option. For example an employer might elect to contribute to a SEP IRA only if a certain threshold of sales or profits is reached. Because the employer contribution can be from 0 to 25% of employees’ wages, the employer can adjust that percentage annually depending on company sales or profits at their discretion.
Is the SEP IRA a good retirement plan option for a family business employing their children?
Yes. The SEP IRA is very egalitarian and requires that contributions for employees be at the same percentage of income as for the business owner. SEP IRA contributions are made by the employer and the contributions are vested immediately. Therefore it is a generous retirement plan and employee benefit, but expensive for employers. However, when the employees are the children the money stays in the family and the parents are helping their children prepare for retirement and the contribution is a tax deductible business expense.
I am a business owner and my spouse is the only employee. Is the SEP IRA our best option?
Maybe. It depends on how much you wish to contribute. A SEP IRA and an Individual 401k should be considered.
An Individual 401k may allow a greater contribution than a SEP IRA due to the way the contribution is calculated. Also, loans are permitted with an Individual 401k.
Compare the features of these retirement plans and determine whether your situation is better suited for a SEP IRA or Individual 401k.
Features and benefits of a SEP IRA
Learn more about SEP IRA benefits.