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SEP-IRA: A Guide for Small Business Owners

Traditional pensions plans and 401(k)'s may not be appropriate for small businesses and the self-employed. However, that doesn't mean there are no other options. Learn about the powerful and adaptable SEP-IRA.

An employer-sponsored retirement plan can be a great way for employers to show workers they care about employees' long-term financial prospects while giving workers a way to save on their taxes.

A simplified employee pension (SEP) plan lets business owners and self-employed individuals use a simple way to make contributions for retirement savings. SEP-IRAs come with streamlined rules that make them less onerous to set up and administer than are 401(k) plans and more complex choices.

Let's see how they work:

  • Employers are responsible for setting up SEP-IRAs for employees. Self-employed workers play the role of employer and employee.

  • SEP-IRAs resemble other types of traditional IRAs. Money put into a SEP-IRA isn't included as income to the employer. (Employees themselves do not contribute unless, as noted, they are their own employers.)

  • Investments in a SEP-IRA are tax-deferred, meaning that you don't have to pay taxes on any income or gains that those investments generate until you make withdrawals from the SEP-IRA.

  • Employers can contribute as much or as little as they want each year. There is a maximum, which usually changes each year. The current limit is 25 percent of an employee's salary, up to $57,000. That's much more than allowed for in alternatives like SIMPLE IRAs and ordinary individual retirement accounts. For high-income individuals, it's hard to match what SEP-IRAs allow.

  • It's easy to set up a SEP-IRA. Most financial institutions make the paperwork uncomplicated, and the IRS offers a standard form — Form 5305 — to establish a SEP-IRA.

  • But there's one thing to keep in mind — if you're a business owner, you generally can't make huge contributions to your own SEP-IRA without making equal percentage contributions to employees' SEP-IRA accounts as well.

In many ways, SEP-IRAs work just like a traditional IRA:

  • Withdrawal of funds prior to age 59½ may be subject to penalty and taxes, except in certain special circumstances.

  • You can't borrow from a SEP-IRA as you can from many 401(k) plans.

  • You can roll your SEP-IRA assets into another IRA account.

  • You can roll assets from another retirement account into your SEP-IRA.

  • You must take required minimum distributions from a SEP-IRA beginning at age 72.

SEP-IRAs make it easier to help employees save for retirement. They have far fewer requirements than alternative pension arrangements. It could be a good move for your small business, even if you are the only employee.

However, the choice of a retirement plan at your business is an important one. The tax and financial implications can be substantial, and there may be other restrictions and provisions. Also, your decision can have a substantial effect on employee satisfaction. Consult with tax professionals at GT to make sure you establish the right plan for your business.

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