SEP IRAs – Tax Deferred, but Not Guaranteed
Retirement plans help you secure a better future position by saving for retirement and can reduce tax liabilities for yourself, your business, and your employees. But when it comes to retirement accounts, how do you know which one to choose?
Many kinds of retirement plans are offered, and it can be difficult to tell which would best suit your business and your employees. In this post, we will cover the setup and eligibility requirements of Simplified Employee Pension Plans (SEP IRAs) and how they can benefit your business, you, and your employees.
SEP IRAs are known for their simplicity and adaptability, making them a compelling retirement plan option. They can be set up with minimal government or legal regulation, and can be established as late as the due date of your business income tax return for the year, including extensions. This means you can have it set up by the year’s end. SEP IRAs can be established by any type of business – LLC, sole proprietorship, corporation, or s-corporations, making them a versatile choice for many businesses.
Setting up a SEP IRA is a straightforward process you can handle using Form 5305-SEP, available on the IRS’s website. This simplicity is a testament to the adaptability of SEP IRAs. However, there are some limitations to using this form.
Such as if you maintain any other qualified retirement plan that is not a SEP, use the services of leased employees, want a plan year other than the calendar year, or want an allocation formula that takes into account Social Security contributions you made for your employees. In these cases, it is recommended that you go through a broker, as they will have to use a prototype document provided by a mutual fund, insurance company, bank, or other qualified institution.
Getting Started with your Retirement Savings
Setting up a SEP IRA with a broker involves discussing your business’s needs and goals, filling out the necessary paperwork, and then having the broker handle the rest. It is also advisable to use a broker to have an individually designed SEP for your business.
Before setting up your SEP IRA, you will need to execute a written agreement to provide these retirement benefits to all of your eligible employees and provide them with information about the agreement. Form 5305-SEP, supplied by the IRS, can be used for this agreement that you can give to your employees, or you’ll be provided with one by your broker. You will also need to provide your employees with the following information:
- Statement that different rates of return and different terms may be provided by IRAs other than the one the employer contributes to.
- A statement that they will receive a copy of any amendments by the SEP administrator within 30 days of the effective date, along with a written explanation of their effects.
- The administrator will notify the participant in writing of any employer contributions made to the participant’s IRA by January 31 of the following year.
Once you have your SEP set up, you’ll need to determine which employees are eligible. To qualify for a SEP IRA, an employee must be at least 21 years old, worked for the employer in at least three of the last five years, and have been paid at least $750. Employers may choose to be less restrictive on these requirements but may not be more stringent. It’s important to note that you must include a SEP IRA for all eligible employees.
What can you do with your Annual contributions?
A SEP IRA allows a lot of flexibility when it comes to the amount a business puts into it. This is highly beneficial for cyclical industries, such as HVAC and plumbing companies, with busy and slow seasons. During the slow seasons, when the business has decreased cash flow, contributions to the SEP accounts can be reduced to help accommodate that decrease.
There is no minimum required contribution, so if you wanted to contribute nothing for a time, you could do that as easily as if you wanted to max out the contribution, which is $69,000 or 25% of their compensation per year as of 2024.
This flexibility ensures that your retirement planning can adapt to your business’s changing financial situation. However, When making contributions, you cannot choose which employees get contributions and which don’t. If you’re contributing, you must contribute to the accounts of all eligible employees.
There are some regulations regarding how much you can contribute to each employee’s SEP. You can only contribute based on the first $345,000 of compensation as of 2024, and you can contribute up to $69,000 or 25% of their compensation, whichever is smaller.
If you are a sole proprietor, your calculations will be slightly different. You’re still regulated to the $69,000 or 25% rule, but you will be able to base this off of your net earnings from self-employment minus one-half of your self-employment tax and contributions to your own SEP IRA. Any contributions made to a SEP IRA must be made by the due date for filing your federal income tax return for the year.
Despite SEP IRAs being 100% employer contributions, the balance of those accounts will always be 100% vested in the employee. This means employees have the final say in how their investments are distributed. When an employee leaves an employer who supplies a SEP IRA, they will be able to take that with them and roll it over to a different IRA.
Controlling your Financial Future
This level of control empowers employees to make decisions that best suit their retirement needs. When deciding which retirement account to go with, it’s important to remember that SEP IRAs are tax-deferred retirement plans, meaning that when your employees retire, their distributions from the account will be taxed. Employees do not make contributions to these retirement accounts but have complete control over the money deposited in them.
Contributions to SEP IRA accounts can be withdrawn at any time; however, they are subject to the general limitations imposed on traditional IRAs. This means any withdrawal is taxable in the year it was received and may be subject to an additional 10% tax if withdrawn before age 59 1/2.
Generally, you have to start taking withdrawals from your SEP IRA when you reach age 72, and your account is subject to Required Minimum Distributions (RMDs) you cannot keep funds in your retirement account indefinitely. Employees may take their SEP IRA with them if leaving a company and roll it over into another qualified plan.
You can easily cancel your SEP IRA anytime by contacting the financial institution holding your retirement accounts or discussing it with your broker. There is no need to notify the IRS if you ever do cancel.
It’s crucial to understand that SEP plans do not come with a 100% guarantee or legal backing. This means that in a year when your business is not performing well, you can choose not to contribute. Other retirement accounts, such as SIMPLE and 401(k) s, have guaranteed requirements for employee contributions. Awareness of this lack of legal backing is key to making informed decisions about your retirement planning and being prepared for potential fluctuations in your business.
When it comes to providing retirement to your employees, each type of retirement account has pros and cons, and it’s up to you to decide which one best fits them and your company and which one’s pros outweigh the cons.
Check out our youtube video SEP IRAs – Tax Deferred, but Not Guaranteed with James to give you a first hand recap.If you are still determining which plan works best for you or need additional help or have any questions, Waterford Business Solutions is happy to help. Feel free to call us at 864-351-0852 or email us at Info@WaterfordBusiness.com.