SEP IRA – A Retirement Plan for the Self-Employed

How are self-employed individuals supposed to save for their future retirement when they don’t have access to a 401(k), 403(b), 401(a), 457, or some other employer-sponsored supplemental retirement plan? Good question. The answer is to sign up for an SEP IRA – a Simplified Employee Pension Plan.

What Is a SEP IRA?

Essentially, a SEP IRA account is a pension plan designed for those who are self-employed. It also works for small business owners, provides tax-deferred benefits, and allows these individuals to save for retirement when they don’t have an employer-sponsored 401(k) plan available.

There are several advantages available through a SEP IRA, including the tax-deferred growth potential and the fact that contributions are tax deductible, just like contributions to a traditional IRA. Contribution amounts are flexible – you can change the amount you contribute next year in comparison to this year’s contribution, so long as you stay within the contribution limits imposed by the IRS.

However, there are a few caveats on who can enroll in this type of plan. You must be either a sole proprietor, a business owner, one part of a partnership, or bring in income as a self-employed individual for providing a service to your customers.

There are a few other rules that must be understood as well. For example, annual contributions cannot exceed either 25% of yearly income or $53,000 (for 2016), whichever is the lower amount. IRS Publication 560 contains special rules that govern the contribution amount for SEP IRAs when you are contributing on your own behalf (as opposed to a small business owner setting up an SEP IRA for an employee).

In a nutshell, an SEP IRA is really not much different from a traditional IRA.

SEP IRA Withdrawal Considerations

One area where an SEP IRA is very similar to a traditional IRA is withdrawals. Like a traditional IRA, SEP IRA contributors must begin taking disbursements from the account at age 70.5. There is no getting around this, so if you don’t need the money, it might be better in a Roth IRA. With that being said, you can continue contributing to the account after this age. There is a penalty assessed on most withdrawals made before the age 59.5 (there are qualifying conditions that don’t incur these penalties).

Do You Need an SEP IRA?

If you’re a self-employed individual or a small business owner, you do need some way to save for retirement. AN SEP IRA is a good option, certainly. However, it’s not the only option available. You can (and should) consider a Roth IRA, particularly if your tax rate will be lower during retirement than it is now. Balance the savings there with the possibility of deducting SEP IRA contributions from your federal and state taxes and determine which option will save you the most money in the long run. Of course, you also need to remember the fact that Roth IRAs do not have the same disbursement requirement when you turn 70.5. You can leave the money in the account and let it grow tax-free as long as you like if it’s not needed.

Retirement planning can be complex. If you’re not sure that an SEP IRA is right for you, speak with a financial planner.