Thinking about establishing a retirement plan for your business? One option to consider is a Simplified Employee Pension (SEP). A SEP is an individual retirement account that an employer or a self-employed person can establish and make pre-tax contributions to on behalf of its employees. Employees cannot contribute to their accounts as they are exclusively employer-funded. SEP plans do not offer Roth or post-tax contributions. A SEP plan can be adopted as late as the extended due date of the employer’s income tax return.
The employer will deduct the contributions to employee SEP accounts as an ordinary business expense. Additionally, SEP contributions are exempt from Social Security and Medicare taxes. Thus, an owner-employee does not pay Social Security or Medicare tax on the SEP contributions. A SEP does not have the start-up and operating costs of a conventional retirement plan which makes the set up more cost effective.
With the SEP, the employer’s contribution to the employee’s SEP cannot exceed the lesser of:
- 25% of the employee’s compensation, or
- $61,000 for 2022 ($66,000 for 2023)
- Self-employed persons can contribute up to 20% of their net self-employment earnings toward their own account.
- Elective salary deferrals and catch-up contributions are not permitted in SEP plans
The IRS sets the annual contribution limits; however, employers can make an annual determination as to the amount they will fund for each employee. Overall, the low start-up costs and flexibility in funding makes a SEP worth considering.