SEP IRA is a type of retirement account that is designed to benefit small business owners. Those businesses that take advantage of SEP IRAs can be organized in a variety of ways; Sole proprietorship, partnership, Limited Liability Corporations (LLC) and S and C Corporations. This type of plan can be used whether or not the business has employees beyond the business owner.
As with other qualified retirement plans, the U.S. Government establishes SEP IRA rules as to who must be included and SEP IRA contribution limits. This plan has high contribution limits which make it of interest to those employers looking to maximize retirement savings. The dollar contribution limit is adjusted annually by the Government; for 2018 the contribution limit is $55,000 or 25% of income if the business owner pays themselves on W-2 from a corporation. If the employer does not pay themselves on W-2, the limit remains $55,000, but the percentage drops to 20% of Adjusted Gross Earnings on the first the first $275,000 of earnings.
If there are employees beyond the business owner involved, the Government requires that anyone over 21 years of age, with 3 years of service in the last 5 years and $600 in compensation for the year must be included in the plan. Being included in a SEP IRA means that the employer will make contributions to the employee’s account on their behalf and that the employee is fully vested when the contributions are made.
The flexibility of this type of plan is very desirable. Employers can change the percentage they contribute each year or skip years as finances allow. This type of plan can also help an employer build loyalty with their employees by providing a generous benefit that is 100% deductible to the business. It is a requirement that any employer who wishes to make a contribution to their own account must make a contribution to all eligible employees based on the same percentage of their earnings that he/she may want to make for themselves. The percentage is based on each employee’s compensation, the percentage of income (up to the maximum) must be no less than what the employer wants to contribute for themselves. The amount of the SEP IRA contribution, therefore, is determined by the compensation that individual earns and the percentage all employees are to receive.
Generally, all contributions and earnings must be left inside the IRA until reaching the age of 59 1/2 in order to avoid premature distribution penalties. IRA participants are required to start making distributions in the year after you reach the age 70 1/2. Failure to take required minimum distributions (RMD) can result in significant tax penalties.