Simple Employee Pension (SEP) IRA – 2022

Picture of a black SEP-IRA booklet on a desktop

The majority of retirement savings among Americans today comes from employer-sponsored retirement plans. However, four out of 10 full-time employees in the U.S. don’t have access to a retirement plan where they work.*

The main reasons for this are that their employers believe it’s too expensive to set up a retirement plan and they don’t have the resources to administer a plan, according to a survey conducted by the Pew Charitable Trusts.* Micro-businesses and the self-employed usually face the biggest obstacles when it comes to setting up a retirement plan.

What is a SEP-IRA?

But there’s some good news for small businesses and self-employed individuals who want to help their employees plan for retirement and save money for retirement themselves. You can establish a Simplified Employee Pension-Individual Retirement Account — better known as a SEP-IRA — with minimal cost and hassle. In fact, a SEP-IRA can be set up by filling out a single IRS form and no annual Form 5500 filing is required.

SEP-IRA Contribution Limits for 2022

The simplicity of SEP-IRAs is one reason why they’re so popular among small businesses and the self-employed. Another reason is the high annual contribution limits. In 2022, you can contribute up to $61,000 or 25 percent of annual compensation (whichever is less) to SEP-IRAs established for yourself and your employees. This will go up by $6,000 in 2023 to a total annual contribution limit of $67,000.

Compare these limits to a traditional IRA or a 401(k) plan. In 2022, the annual contribution limit for traditional IRAs is just $6,000 (or $7,000 for individuals 50 years of age or over) while the annual contribution limit for 401(k)s in 2022 is $20,500 (or $27,000 for individuals 50 years of age or over).

How SEP-IRAs Work and Eligibility Rules

Once a business establishes a SEP-IRA, individual IRAs are set up for each employee. The business then makes tax-deductible contributions into these accounts. Note that employees can’t make contributions to their accounts — only employers can contribute to SEP-IRAs.

There are no restrictions on the sizes or types of businesses that can use a SEP-IRA. Sole proprietorships, S corporations, C corporations, partnerships, and LLCs all may qualify to establish and offer a SEP-IRA too their employees.

But there are eligibility criteria for employees, who must be at least 21 years old and have worked for the company for at least three of the past five years. They also must have received at least $600 from the employer in compensation between 2016 and 2020 and $650 in compensation in 2021. Employees own their SEP-IRA accounts and control how the money is invested.

There’s one important distinction with SEP-IRAs that some owners aren’t aware of: Businesses must contribute the same percentage of compensation to all eligible employees’ accounts, including the owner. So, if you wanted to contribute a healthy 25% of your annual compensation to your own SEP-IRA, you’d have to contribute this same percentage to each eligible employee’s account. But this might not be financially feasible.

Benefits of a SEP-IRA

There are a number of potential benefits of setting up a SEP-IRA for yourself and your employees, including the following:

  • The annual contribution limits are much higher than the limits associated with traditional IRAs and 401(k)s.
  • Contributions are tax-deductible to the business, which may reduce your current income tax bill.
  • Setup and administration are relatively easy and there’s no annual Form 5500 filing requirement.
  • Contributions grow on a tax-deferred basis, which can boost the size of the account over the long term.
  • SEP-IRAs can be combined with traditional IRAs and Roth IRAs.

There is flexibility when it comes to how much money is contributed to accounts each year — this amount can change each year.

Drawbacks of a SEP-IRA

Keep in mind that there are a few potential drawbacks to SEP-IRAs, including the following:

  • You must contribute the same percentage of compensation to all eligible employees’ accounts, as explained above. This tends to make SEP-IRAs more attractive to self-employed or micro-businesses with just a few employees.
  • There is not a Roth version of a SEP-IRA so you and your employees can’t save for retirement on a tax-free basis.
  • Required minimum distributions (RMDs) from the account must begin when you and employees reach age 72.
  • Money withdrawn from the account before age 59½ may be subject to a 10% early withdrawal penalty and current taxation at ordinary income tax rates.

How to Open a SEP-IRA

You can easily open a SEP-IRA online yourself by following these four steps:

  1. Choose an investment company to serve as your account provider (e.g., Fidelity, E*TRADE, Charles Schwab).
  2. Create a formal written plan agreement using IRS Form 5305-SEP.
  3. Let eligible employees know about the plan by giving them a copy of IRS Form 5305-SEP or a similar form supplied by your account provider.
  4. Establish IRAs for each eligible employee with your account provider.

The 2022 deadline for establishing and funding a SEP-IRA is April 18, 2023. This means you have all the way until mid-April of next year to set up a SEP-IRA and make contributions that you can deduct from your business’ 2022 taxable income.

How We Can Help Your Business

The team at C.W. O’Conner Wealth Advisors helps business owners and self-employed individuals set up the right retirement plans for themselves and their employees, including SEP-IRAs. Call us directly at 770-368-9919 or email Cliff at cliff@cwoconner.com or Kevin at kevin@cwoconner.com to learn more.

* https://www.pewtrusts.org/~/media/assets/2017/01/small-business-survey-retirement-savings_f.pdf

Cliff is the founder and president of C.W. O'Conner Wealth Advisors, Inc. Cliff earned a Bachelor of Business Administration degree in Accounting from Georgia State University.

Kevin O'Conner is a financial planner with C.W. O'Conner Wealth Advisors, Inc. He earned a Bachelor of Business Administration degree in Business Management from Georgia College, and is a Certified Investment Management Analyst (CIMA).