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Understanding SEP IRAs: A Comprehensive Guide for Business Owners

At O1ne Mortgage, we understand the importance of planning for the future. Whether you’re a business owner or a self-employed individual, securing a comfortable retirement is crucial. One effective way to achieve this is through a Simplified Employee Pension (SEP) IRA. In this article, we’ll explore what SEP IRAs are, their benefits, and how you can set one up for yourself and your employees.

What Is a SEP IRA?

A SEP IRA is a tax-advantaged individual retirement account designed for business owners and self-employed individuals. It allows employers to contribute to their employees’ retirement funds, as well as their own. Contributions to a SEP IRA are tax-deferred, meaning they can be deducted on your tax returns, and distributions are taxed as regular income upon withdrawal during retirement.

SEP IRA Basics

While SEP IRAs share many similarities with traditional IRAs, there are some key differences. Here are the basic rules for SEP IRA plans:

• Each employee must have an individual SEP IRA account.
• All contributions are made by the employer; employee contributions are not allowed.
• The contribution rate must be the same for all eligible employees.
• Contributions can vary from year to year.
• Contributions must be made by the company’s tax filing deadline.

SEP IRA Contribution Limits

For the 2023 tax year, the maximum contribution to a SEP IRA is $66,000 or 25% of compensation, whichever is less. In 2024, this limit increases to $69,000, with a compensation limit of $345,000. These limits are significantly higher than those for traditional IRAs, Roth IRAs, and SIMPLE IRAs, making SEP IRAs an attractive option for business owners looking to maximize their retirement savings.

SEP IRA Rules

The IRS has specific rules for setting up and maintaining SEP IRAs. Here are some important details:

Who Can Establish a SEP?

Businesses of any size, including sole proprietors, partners, corporations, and nonprofits, can set up a SEP IRA plan. Self-employed individuals who serve as their own sole employee are also eligible.

Eligible Employees

Employers can set up SEP IRA plans for their eligible employees, who must meet the following requirements:

• Age 21 or older
• Worked for the employer for at least three of the past five years
• Not covered by a union agreement
• Not a nonresident employee without U.S. source income
• Received at least $750 in compensation

Self-Employment Contributions

For self-employed individuals, SEP IRA contributions cannot exceed 25% of compensation, defined as net earnings from self-employment minus half of self-employment tax and any SEP IRA contributions. For more details, refer to IRS Publication 560.

Tax Deductions for Contributions

Contributions to a SEP IRA are tax-deductible, including those made to employees’ accounts. The maximum deduction is the total amount of contributions or 25% of compensation, whichever is less. Employees can exclude contributions from their gross income, and these contributions are not subject to federal tax withholding, Social Security, Medicare, or federal unemployment taxes.

Vesting

Contributions to SEP IRAs are always fully vested, meaning employees have immediate access to the funds.

Income Taxes on Distributions

Withdrawals from SEP IRAs are subject to income taxes, and an additional 10% early withdrawal tax applies if taken before age 59½.

SEP IRA Pros and Cons

Pros

• Higher contribution limits compared to traditional IRAs and Roth IRAs.
• Fewer rules and filing requirements than 401(k) plans.
• Flexible contribution amounts from year to year.

Cons

• No Roth option available.
• Employee contribution rates must be equal to the employer’s rate.
• All contributions are made by the employer; employees cannot contribute.

How to Open a SEP IRA

Setting up a SEP IRA involves three basic steps:

1. Adopt a formal written agreement using one of the following options:
   • Complete and sign Form 5305-SEP to adopt an IRS model SEP.
   • Select an IRS-approved prototype SEP from a financial institution.
   • Create your own individually designed SEP plan document.
2. Provide each eligible employee with information about the SEP IRA plan.
3. Open a SEP IRA for each eligible employee through a brokerage firm, bank, credit union, or insurance company.

Ensure that you set up and fund your SEP IRA by the due date for your business’s income taxes to deduct contributions on your tax return. Contributions for future years are also due on tax day.

The Bottom Line

Whether you’re looking to save for your own retirement or help your employees achieve their retirement goals, a SEP IRA offers a straightforward way to make tax-deductible contributions with high limits. For solo business owners and entrepreneurs, SEP IRAs are worth considering as part of your retirement planning strategy.

At O1ne Mortgage, we’re here to help you navigate your financial future. If you have any questions or need assistance with mortgage services, don’t hesitate to call us at 213-732-3074. Our team of experts is ready to assist you with all your mortgage needs.

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