Many small businesses and self-employed workers don’t have access to some of the well-known retirement saving plans, like 401(k)s or pension plans. But they do have something else called a simplified employee pension plan, or SEP, which is available to small businesses of any size. They grant retirement savings opportunities for self-employed individuals as well as employees of participating small businesses.
SEP IRAs involve opening a traditional IRA, or individual retirement account, for each eligible employee. The employer can then contribute to this account each year, up to the annual contribution limit set by the IRS. But there are limits to how much an employer can add to a SEP IRA, as well as tax implications.
What are the SEP IRA contribution limits for 2022?
Many self-employed individuals will use SEP IRAs as a way of building retirement savings for their own future. If they also have employees, though—or expand their business in the future and add employees, everyone must be offered proportionately equal contributions for the year. Also, an employer must set up SEP IRAs for all employees if they choose to use such a savings plan, meaning no eligible employees can be excluded.
Contributions are calculated as a percentage of a worker’s earnings. So, if a business owner tucks away 20% of their earnings in a SEP IRA each year, they must also contribute 20% of their employees’ earnings to SEP IRA accounts.
The limits for 2022 contributions are 25% of the employee’s pay or $61,000, whichever is less. This means that if an employee has a salary of $100,000, the contribution limit to their SEP IRA is capped at $25,000 for that year. If they make $250,000, however, the contribution cannot exceed the IRS annual maximum of $61,000.
SEP IRA plans are different from most other retirement savings plans, in that only the employer is allowed to contribute. Elective salary deferrals are not permitted, meaning that employees cannot choose to add retirement savings above and beyond what their employer contributes.
Unlike other IRAs, SEP IRAs also don’t allow what are known as catch-up contributions, even among employees 50 or older.
Who can participate in an SEP IRA?
The IRS governs the eligibility requirements employers may institute for participation in an SEP plan. While eligibility rules may be less restrictive than those established by the IRS, they cannot be more restrictive. The maximum eligibility restrictions are:
- Employees must be age 21 or older.
- They must have worked for the employer for three of the last five years.
- They must have received compensation of $650+ from the employer each year.
Employers, however, may exclude some employees from a SEP plan, including those who are non-resident foreign employees (and don’t earn U.S. wages from the employer) and those covered by a union contract.
An employer can establish and contribute to a SEP IRA plan up until the federal income tax filing deadline for that year. Contributions are reported on IRS Form 5498, which shows how much was contributed to the account, the account’s fair market value (FMV) at year’s end, any account conversions (rollovers) that were made, and any anticipated required minimum distributions (RMDs), or withdrawals from an account mandated by IRS rules.
What are the tax implications?
Employers sponsoring a SEP IRA have until April 15 (or, depending on the year, as late as April 18) to make equal contributions into all eligible SEP accounts, including their own SEPs as well as their employees’. As long as these contributions are made before the tax deadline—not including any extensions that the employee or employer may have been granted—they can be counted toward the previous tax year.
Both employees and employers are able to deduct reported SEP plan contributions from their gross income. This can help to lower tax filer’s adjusted gross income (AGI) for the year and, in turn, their overall tax burden.
Can a person contribute to a SEP, traditional IRA, and Roth IRA in the same year?
There are many different types of IRAs to choose from when developing a personal retirement savings strategy. SEP IRAs, which utilize traditional IRAs, are just one option.
Employees can also opt into other IRAs in the same year that their employer funds a SEP IRA on their behalf. For example, an employee may choose to add funds to a Roth IRA at the same time, as long as they meet the IRS’s income limits for the account.
Since Roth contributions are made by the employee and SEP IRA contributions are made by the employer, a self-employed person could theoretically max out contributions to both kinds of accounts, putting away a total of $67,000 ($61,000 in the SEP IRA and $6,000 in the Roth IRA)..
Individuals who are both self-employed and work for another employer at the same time can also establish and fund a SEP IRA for themselves while contributing to an employer’s SIMPLE IRA plan (if offered). The limits for SEP IRA contributions are separate from SIMPLE IRA limits, even if the same person is making the contributions.
So, theoretically, a self-employed individual could contribute up to $61,000 into an eligible SEP IRA, and also contribute up to $17,000 (the $14,000 maximum for 2022 plus up to $3,000 extra in a catch-up contribution) into the SIMPLE IRA that they’re offered by a separate employer. They will just need to note the contribution limits for each plan, based on income, to ensure compliance with the IRS.
SARSEP plans (salary reduction simplified employee pension) are no longer offered. These plans gave employees the opportunity to make elective salary withdrawal contributions into their SEP retirement accounts. For SARSEP plans that are still active and in operation, participants can continue to make salary deferrals up to the lesser of $20,500 (for 2022) or 25% of their annual compensation.
The bottom line
Saving for retirement is often a lengthy and complex process, and may involve many different retirement accounts and strategies. This can be especially true for self-employed workers, who are forced to research and establish their own retirement accounts, rather than just participating in a plan that an employer offers, such as a 401(k).
SEP IRAs were designed mainly for small business owners, allowing them to save up to $61,000 or 25% of their income each year. Depending on how much that business owner earns—and whether they are also employed by another company—those retirement savings efforts can be further compounded with additional retirement account options.