Payments made to a simplified employee pension (SEP) individual retirement account (IRA) are tax-deductible for employers or the self-employed, but there is an annual limit on contributions.
SEP IRAs are funded solely by an employer using tax-deductible dollars. For 2024, an employer can contribute up to 25% of an employee's compensation or $69,000, whichever is less. The account isn't tax-deductible for the employee, unless they are self-employed, but is funded with tax-deferred dollars.
Key Takeaways
- Employers can deduct payments to a simplified employee pension (SEP) IRA for one or more employees up to set limits.
- Business owners who start a SEP IRAmay be eligible for a tax credit of $500 or up to $5,000 per year, depending on how many employees are participating.
- SEP IRA contributions and earnings can be withdrawn at any time, subject to the general limitations imposed on traditional IRAs.
What Is a SEP IRA?
A SEP IRA is a type of traditional IRA available to self-employed individuals, freelancers, and small-business owners. Employees aren't able to contribute to a SEP IRA that the company opens on their behalf. Contributions come solely from the employer, and they aren't required to contribute every year.
When making SEP IRA contributions, employers are required to contribute an equal percentage of income for every employee. This applies to every employee who performed services during the year, even for employees who die or terminate employment before the contributions are made.
Additionally, business owners who start up a SEPmay be eligible for a tax credit of up to $5,000 per year for the first three years that theSEP account is open.
The self-employed are permitted to contribute up to 25% of net earnings to a SEP IRA, or the annual contribution limit, whichever is less.
What Is the Eligibility for an Employer’s SEP?
Once a business owner has set up a SEP IRA, they must include all eligible employees on the plan, who are defined as:
- Employees 21 or older, who
- Have worked for you for at least three of the past five years, and who
- Have earned at least $750 in income from your business for 2024
- Not having been paid more by the business than the 2024 maximum annual limit of $345,000
An employer could lower eligibility thresholds, for example, by lowering the age or minimum service requirements. However, the eligibility requirements must apply to everyone equally.
For individuals who aren't self-employed, the compensation used to determine SEP IRA contributions includes wages, salaries, fees for professional services, commissions and tips, fringe benefits, and bonuses. Compensation generally includes amounts deferred, at the employee's election, under benefits plans such as 401(k) plans, 403(b) plans, SIMPLE IRAs, Section 457 plans, and Section 125 cafeteria plans.
Contribution Deadline and Withdrawals
The deadline for establishing a SEP IRA planand making contributions is the filing deadline for the employer's tax return, including extensions. Catch-up contributions aren't allowed in SEP IRAs, as they are made by individuals rather than employers.
SEP IRA contributions and earnings can be withdrawn at any time subject to the general limitations imposed on traditional IRAs. A withdrawal is taxable in the year received. If a participant makes a withdrawal before age 59½, a 10% additional tax generally applies. SEP IRA contributions and earnings may be rolled over tax-free to other IRAs and retirement plans after two years of participation.
Who Can Contribute to a SEP IRA?
Only an employer can contribute to a SEP IRA—a variation of a traditional IRA that is strictly for self-employed people, freelancers, and small business owners. The employer doesn't have to contribute every year, but must include an equal percentage of income for each employee.
Will a SEP IRA Reduce Taxes?
For an employer, a SEP IRA will reduce taxes, but that's not so for an individual. SEP IRAs are funded by tax-deductible dollarsand are limited to up to 25% of an employee's compensation or $69,000, whichever is less in 2024.
Does a SEP IRA Reduce Self-Employment Tax?
If you are a self-employed person who contributes to a SEP-IRA, you will see a reduction in your self-employment tax, as the contribution will lift business expenses, lowering net profit, and therefore reducing the self-employment tax and income tax.
The Bottom Line
Small-business employers and others can deduct from their tax bill payments to a SEP IRA for one or more employees up to limit amounts set by the IRS. Business owners who start a SEP IRAalso may be eligible for an annual tax credit, depending on how many of their employees participate.
These plans are funded solely by an employer using tax-deductible dollars, so employees can't contribute to one unless they are self-employed, but the contributions they receive are tax-deferred. For 2024, an employer can contribute up to 25% of an employee's compensation or $69,000, whichever is less.
