Open a SEP IRA: Contribution Limits and Rules

Time to SEP it up!

Are you a self-employed business owner that is looking for a cost effective to lower your taxes and help you save for retirement?

If that fits your profile then opening a SEP (Simplified Employee Pension) IRA might be a good retirement account to start for your business.

When I was researching what would be the best retirement plan to set up for myself when I first became self-employed, I narrowed it down between the SEP IRA and the Solo 401k.

Both allowed very favorable contribution limits, but the administrative costs and ease of setting up made the SEP IRA the easy answer.

If you are considering opening a SEP IRA for your business, here’s what you need to know about the SEP IRA rules and contribution limits and how easy it is to open one.

SEP IRA’s Have Tax Deferred Compounding

Just as a traditional IRA or 401k, your contributions are pre-tax and can significantly lower your taxable income.

You contribute pre-tax dollars to a SEP IRA, and that has the effect of lowering your tax bill. The money in the IRA grows tax-deferred, and your business doesn’t pay any taxes on the IRA earnings. The assets can be invested in many ways.

The traditional IRA rules apply. When you take the money out of a SEP IRA for retirement, you pay ordinary income taxes on it. (Should you withdraw SEP IRA assets before age 59½, you’ll likely be assessed a penalty, with some exceptions.)

SEP IRA Contributions are Discretionary.

One huge bonus for business owners is that you are not required to contribute to a SEP IRA each year.  In addition, there is not a set amount that you have to put in.  This flexibility is priceless for a business owner that has fluctuating net income year after year.

Also, you are not subject to the typical IRA deadline to contribute: April 15th.  If you file a tax extension, you can wait until then to make the contribution.

How Much Can you Contribute to a SEP IRA?

In 2014, you can contribute up to 25% of an eligible employee’s compensation, up to a limit of $52,000 ($53,000 in 2015).  No catch-up contributions are permitted for older employees.  Based on the 25% rule the income threshold is $265,000.  Over an above that you will not be able to contribute any more.  That’s when you might want to consider some other business retirement plans.

YearMaximum Annual ContributionMaximum Considered Compensation

What Makes Employees Eligible for a SEP IRA?

If you have employees, then provided they pass a series of test, you will have to contribute the same percentage to them- just based on their salary- not yours. Generally, employees of a small business are eligible for a SEP IRA if they

  1. Are older than 21,
  2. have worked for the business in at least three of the five years preceding the year in which the IRA contribution is made,
  3. have received $550 or more in compensation from the business in 2009 (this can rise with COLA adjustments in future years). However, the IRS states that an employer “may use less restrictive requirements to determine an eligible employee.”

However, the IRS states that an employer “may use less restrictive requirements to determine an eligible employee.”

Employees covered by a union contract may be excluded from a SEP, as well as non-resident aliens who have not earned income from your business.

All eligible employees must participate in the SEP, including part-time and seasonal workers and employees who die, quit, or get laid off or fired during the year.

Opening a SEP IRA is Easy Breezey.

Opening a SEP IRA is just as easy opening a regular investment account. You can open up one of these plans with the help of almost any financial advisor or financial institution.

In fact, you can even have other retirement plans at your business in addition to SEP IRAs, and you can set up a SEP IRA for your small business even if you are already participate in another retirement plan at another company.

Sole proprietors, partnerships, and corporations can all create SEPs. In fact, they may qualify for annual tax credits of up to $500 during the plan’s first three years, which can be applied toward the plan’s start-up costs. So if you have a small business or work on your own and you want a retirement plan that works for your future without a lot of hassles, a SEP IRA may be right for you.


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Comments | 6 Responses

  1. Brett Quayle says

    Hi Jeff,

    Great website. I’m a financial planner myself, and have a situation where I’m putting together a SEP IRA for a doctor friend of mine. With him being self-employed, isn’t it just 20% up to 245,000 for him? If that is the case, can he do 20% for employees or does he have to do 25%???? Again, great info on this site.

  2. Scott Zito says

    I am interested in purchasing a small $40,000 investment property. Is it possible to use the money from my SEP IRA without going the traditional bank loan. Instead useing my money(sep ira) and paying back my money(sep ira) with interest? Thanks, Scott

    • JM says

      No, IRAs can’t be used as collateral and no loans can be made from them. In addition, purchasing investment property is not an allowed exception for penalty on early withdrawal assessed by the IRS. You could take funds out temporarily, but unless you can re-deposit the amount back to the account within 60 days from withdrawals date, or you are over age 59 1/2 you will have a tax penalty. The amount of the distribution will also be taxed as ordinary income.

  3. Brad Barton says

    hi Jeff say im disabled an on ssn im about to rap up my workers com case an im going to take a settlement can i open up a sep ira even though i cant work any more an have not worked cents 2008. Brad

    • Jeff Rose says

      @ Brad Unless you are a business owner that has current self-employment income you won’t be able to open a SEP IRA.

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