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SEP IRA Benefits For Small Business Owners & Employees

June 5, 2022

Learn all about why a SEP IRA can come with many benefits and how it offers a wide variety of investment options, flexible contributions, and high annual limits.

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Simplified employee pension (SEP) plans are a type of workplace retirement savings account. Available to any size business, these retirement savings plans enable small-business owners to contribute to individual retirement accounts (IRAs) for themselves as well as their eligible employees. 

SEP IRAs can come with many benefits, especially for smaller businesses and sole proprietors who may find the expenses associated with establishing a company 401(k) too burdensome.

What are the SEP IRA benefits for business owners?

Business owners are able to open and contribute to a SEP retirement plan whether they work as a sole proprietor, with their spouse, or employ hundreds of others within their business. However, SEP IRAs are a popular retirement savings option for self-employed individuals looking to maximize their retirement contributions while also limiting exposure to setup fees, income taxes, and other expenses.

Some SEP IRA benefits for employers and self-employed individuals include:

Simple setup. A SEP can be established through any number of financial institutions, including brokerages as well as many banks and credit unions. The process usually involves minimal documents and can oftentimes be completed online. The financial institution will then hold and manage an IRA for each eligible employee who receives employer contributions, under the umbrella of that SEP.

Low (or no) costs. Few brokerages charge fees for opening, holding, or even managing a company SEP plan. This makes setting up these retirement accounts cost-effective for both the employer and self-employed individual.

Contribution flexibility. One notable rule of SEP IRAs is that contributions must be equal for all eligible, employed individuals. So if a small-business owner contributes 15% to their own SEP IRA, they will need to contribute the same to each eligible employee’s account. 

However, contributions aren’t required and can be adjusted from year-to-year. In prosperous times, business owners may choose to make larger contributions, while in financially tighter years, owners may opt to reduce contributions—or temporarily halt them altogether. As long as all employees are treated equally, there is no contribution requirement. 

Higher contribution maximums. Compared to traditional or Roth IRAs, this self-employment retirement plan allows for greater retirement savings. For 2022, business owners may contribute as much as $61,000 (or 25% of their compensation, for the year) into a SEP IRA, compared to just $6,000 (or $7,000, if they’re over 50 and qualify for the catch-up contribution) with traditional IRAs or Roths.

Tax advantages. Business contributions are tax-deductible. Plus, the contributions made into a SEP IRA are not subject to federal income tax withholdings or Social Security, Medicare, or unemployment taxes. 

What are the benefits of a SEP IRA to employees?

The advantages of a SEP IRA aren’t just limited to the business owner or self-employed individual. Employees working for a company that offers a SEP plan can also enjoy contribution and SEP IRA tax benefits.

Employer-only contributions. Contributions to a SEP IRA can only be made by the employer. So, employees working for a company with an established SEP IRA can enjoy retirement savings contributions that don’t come out of their own salaries.

Gross income deductions. Even though the employer is the one making contributions to the SEP IRA, the employee can subtract any employer contributions made on their behalf from their gross income for the year. This lowers an employee’s tax liability. 

Investment and fee flexibility. Most 401(k) plans allow employees to choose how their retirement savings are invested from a short list of options that the employer curates. With a SEP IRA, though, employees can opt for any investment option that is offered by the brokerage or financial institution that holds the account. This also allows employees to choose investments and funds that may have lower expense ratios or management fees.

Deferred taxes. As with traditional IRAs, account holders do not owe taxes on the funds in their account until they withdraw them in retirement. After age 59 ½, they can be withdrawn and will be counted as ordinary income for that tax year; required minimum distributions begin at age 72.

SEP IRAs vs. other retirement plan options

Self-employed individuals are tasked with taking their retirement into their own hands. This means considering which retirement plan options are most tax-advantaged, have the highest potential for growth, offer the lowest fees and expenses, and ultimately, are best-suited for a self-employed individual’s situation.

SEP IRAs are one possible option, giving small-business owners an affordable retirement savings plan with flexibility—whether they are sole proprietors or have employees. 

Another option is the Solo 401(k). This is intended for self-employed individuals without employees. Also known as a one-participant plan, the Solo 401(k) can only be used by the employee and his or her spouse. 

A Solo 401(k)  offers a similar total contribution limit as a SEP IRA—$61,000 total in 2022, not including catch-up contributions—though this maximum can only be met if the individual contributes both as the employee (up to $20,500 in 2022, or up to $27,000 if over age 50) and as the employer (up to 25% of their annual compensation).

For small-business owners who have additional employees to consider, a traditional 401(k) plan is another option. These plans allow for maximum contributions up to $61,000 in 2022 (or $67,500 for those age 50 or older), but can be much more complex and costly for the business owner.

The bottom line

Planning for retirement is just as important for small-business owners as for employees. But for self-employed individuals, determining which retirement savings account to use can at times be confusing. 

A SEP IRA is one option for small-business owners, whether they operate as a sole proprietor or have employees working for the company. SEP IRAs offer a wide variety of investment options, flexible contributions, and high annual limits. They also have lower fees and administrative costs than other types of retirement plans, such as 401(k)s, though they do require business owners to contribute equally to all eligible employees’ accounts.

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