Content of the material
- 2022 SEP-IRA Contribution Limits
- Related Questions
- SEP IRA Rules
- Do You Pay Taxes on a SEP IRA?
- SEP Plan Contribution Limits
- Which Employees Qualify for a SEP IRA?
- SEP plan limits
- Set up and Contribution Deadline
- How Do I Open a SEP IRA?
- Participating in a SEP Plan
- Who can use a SEP IRA?
- Motley Fool Returns
2022 SEP-IRA Contribution Limits
Unlike other retirement plans, employees do not make their own contributions to a SEP-IRA. Only the owner of the small business can make them for employees. Employees are often free to still contribute to a separate IRA or Roth IRA.
There are a couple of limitations when it comes to SEP-IRA contributions. An employer can contribute to an employee’s SEP-IRA up to either 25% of the employee’s compensation or $61,000, whichever is less.
Up to $305,000 of an employee’s compensation may be considered. These contribution limits reflect the 2022 tax year and apply to both employees of small businesses and the self-employed. For 2021, the limit was 25% of earnings up to $58,000.
Those who have a Salary Reduction Simplified Employee Pension (SARSEP) plan that was established before 1997 were entitled to make elective salary deferral contributions. If you still have your plan, you can make elective deferral contributions up to $20,500 or 25% of your compensation, whichever amount is less.
It’s important to note that you cannot make elective salary deferrals or catch-up contributions to regular SEP plans. You also cannot contribute property to a SEP-IRA. All contributions must be made in cash. If you accidentally contributed more than the limits allow, visit the IRS website to learn how to correct the contribution mistake.
Have questions about our SEP-IRA? Here are responses to some of the most common questions we hear. If you have a specific question that’s not answered here, please call us at 800-435-4000.
- How do I establish a SEP-IRA plan?
To get detailed instructions see Establish Your Plan, or call us at 800-435-4000 if you have questions.
- Who is a SEP-IRA for?
A Simplified Employee Pension Plan (SEP-IRA) is specifically designed for self-employed individuals and small business owners who want to save for retirement without getting involved in complex plan administration. If you are self-employed or have few employees, and if you want flexibility in the amount you contribute annually—particularly if you want to make high contributions—a SEP-IRA might be right for you.
- What are the eligibility requirements for a business to establish a SEP-IRA?
Almost any type of business is eligible to establish a SEP-IRA, from self-employed individuals to multi-person corporations (including sole proprietors, partnerships, S and C corporations, and limited liability companies [LLCs]), tax-exempt organizations, and government agencies.
- What are the tax advantages of a SEP-IRA?
Employer contributions are tax-deductible. Earnings grow tax-deferred and are not taxed until they are withdrawn.
- How is a SEP-IRA funded?
A SEP-IRA is funded with employer contributions only. It does not need to be funded annually, but if you have employees and contribute for yourself, you must contribute for all eligible employees, including those who have terminated employment during the year. Full vesting is immediate.
- What are the SEP-IRA contribution limits?
You may contribute up to 25% of compensation (20% if you’re self-employed4) or $58,000 for tax year 2021 or $61,000 for tax year 2022, whichever is less.
- What is the contribution deadline for SEP-IRA?
A SEP-IRA can be opened and contributions made until the employer’s actual tax-filing deadline, including any extensions.
- When should I establish and fund my SEP-IRA plan?
Plans must be established by the tax-filing deadline of the business (generally April 15, plus extensions) in order to contribute for that tax year. This is also the deadline for annual contributions.
- What do I need to know about administering a SEP-IRA?
SEP-IRAs are easy to set up and maintain, and no tax filing is required. Schwab reports all contributions and end-of-year fair market value on Form 5498 by May 31 each year.
- What are the rules for withdrawing from a SEP-IRA account?
You can start making penalty-free withdrawals from your account after age 59½. If you do not start Required Minimum Distribution (RMD) withdrawals by age 70½ (if you were born before July 1, 1949) or age 72 (if you were born on or after July 1, 1949), or take less than the required amount, you will face a 50% penalty on the total amount of the distribution. There are certain exceptions for which you can withdraw funds before age 59½ without taking a 10% penalty, including a rollover to another IRA, some higher education expenses, qualified first-time home purchase expenses, death, disability, and certain medical expenses.
- What are the SEP-IRA rules?
SEP-IRA plans (Simplified Employee Pension) are designed to allow small-business owners or the self-employed to make sizable contributions to a retirement plan without filing a tax form. SEP-IRAs require little administration. Employees can contribute up to 25% of your annual income. If you’re self-employed, you can contribute 20% (after subtracting the self-employment tax deduction of your businesses’ net profit or equivalent to the employee percentage given). You can decide what amount to contribute each year, from $0 to the maximum SEP-IRA contribution, 25% of compensation (20% if you’re self-employed4) or $58,000 for tax year 2021 or $61,000 for tax year 2022, whichever is less. Rollover or transfer rules for a SEP-IRA are the same as traditional IRA plans. That means you can roll over funds to any qualified retirement plan, such as a 401(k). Distributions or withdrawals from a SEP-IRA are penalty-free after age 59½. If you do not start Required Minimum Distributions (RMDs) by age 72, you will face a 50% penalty on the total amount of the distribution. Withdrawals before age 59½ are subject to a 10% penalty. There are certain exceptions for which you can withdraw funds before age 59½ without taking a 10% penalty, including a rollover to another IRA, some higher-education expenses, qualified first-time home purchase expenses, death, disability, and certain medical expenses.
SEP IRA Rules
SEP IRAs were primarily designed to encourage retirement benefits among businesses that would otherwise not set up employer-sponsored plans. Not all businesses can establish them, though. Sole proprietors, partnerships, and corporations are eligible.
As for participants, too high an income can be a limitation—the 2021 eligible compensation limit is $290,000 in 2021, rising to $305,000 in 2022. Unlike qualified retirement plans, the SEP does not allow participants, including the business owner, to borrow up to the lesser of 50% or $50,000 of their vested balance, however.
Moreover, certain types of employees may be excluded by their employer from participating in a SEP IRA, even if they would otherwise be eligible based on the plan’s rules. Workers who are covered in a union collective bargaining agreement for retirement benefits, for example, can be excluded. Workers who are nonresident aliens can also be excluded as long as they do not receive U.S. wages or other service compensation from the employer.
SEP contributions and earnings are held in SEP IRAs and 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, generally a 10% additional tax applies.
SEP contributions and earnings may be rolled over tax-free to other IRAs and retirement plans. SEP contributions and earnings must eventually be distributed following the IRA-required minimum distributions rules.
Do You Pay Taxes on a SEP IRA?
You are generally not required to file annual financial reports with the federal government after a SEP IRA is established. Most of the tax rules for individual accounts within a SEP IRA are the same as those applied to traditional IRAs.
Typically, 100 percent of all employer contributions to a SEP IRA are tax-deductible for your small business.
Contributions to a SEP IRA account are made with pre-tax earnings, and all investments within the account grow tax-free.
Employees and employers can start withdrawing money from an account at 59.5 years old. The IRS levies a 10 percent tax penalty for early withdrawals, but there are exceptions to this penalty in certain circumstances, such as death or disability.
Once you turn 72 years old, you must begin making required minimum distributions from your account. The IRS calculates the amount of this minimum withdrawal based on how much money is in the account at the end of the year and the account owner’s life expectancy.
Employees can also roll over their SEP IRA funds into another qualified account, such as a traditional IRA, without facing tax penalties.
SEP Plan Contribution Limits
SEP IRA contributions are made by the employer, pre-tax. That means an up-front tax break or tax-deferred savings for your business. The employee doesn’t pay taxes until they withdraw the money from the account during retirement. Another big advantage of a SEP IRA is the higher contribution limit.
In 2021, the SEP contribution limit is up to 25% of individual compensation, with a maximum of $58,000. That amount increased for 2021.
The annual contributions allowed in a SEP are much higher compared to a maximum of $6,000 ($7,000 with a catch-up contribution if 50 or older) allowed in a Traditional or Roth IRA. The SEP IRA doesn’t allow for catch-up contributions at age 50 like other IRAs because the employer makes the contributions to the SEP, not the employee.
Since the employer is making the contributions, the amounts are related to the employees’ salary or wages. This means that everyone’s contribution is the same percentage of their individual salary.
For example, if you make a 25% SEP IRA contribution to yourself as the owner, you also must make a 25% employer contribution for your employees who qualify to participate in the plan. Contributions must be made in cash; you cannot contribute property.
Another important thing to note is that an employer contribution to a SEP-IRA won’t affect the amount an employee can contribute to a Roth IRA or a Traditional IRA. However, it may prevent the employee from receiving a tax deduction for contributions to a Traditional IRA.
Which Employees Qualify for a SEP IRA?
If you set up a SEP IRA plan for your small business, you must include all of your employees who are 21 or older, have performed services for the business in at least three of the last five years and have received at least $650 in compensation from your business for the year.
This includes part-time employees, seasonal employees and any who left the business during the year. You can include workers in your plan who do not meet these requirements, but you don’t have to.
Some employees may be excluded from a SEP IRA, at an employer’s discretion, including:
• Employees who are covered by a collective bargaining agreement, if retirement benefits were part of the bargained plan.
• Nonresident alien employees who didn’t earn any income from you in the U.S.
• Employees who received less than $650 in compensation during the year or are younger than 21.
SEP plan limits
Your contributions to your SEP plan (that is not a SARSEP) are not reduced by the contributions you or your employer make to your employer’s SIMPLE IRA plan.
SEP plans (that are not SARSEPs) only allow employer contributions. For a self-employed individual, contributions are limited to 25% of your net earnings from self-employment (not including contributions for yourself), up to $61,000 for 2022 ($58,000 for 2021; $57,000 for 2020). You can calculate your plan contributions using the tables and worksheets in Publication 560.
If your business sponsors another defined contribution plan in addition to your SEP plan (for example, a profit-sharing plan or a 401(k) plan), then your contributions for yourself to all these plans may not exceed 25% of your net earnings from self-employment (not including contributions for yourself), up to $61,000 for 2022 ($58,000 for 2021; $57,000 for 2020). Note that salary deferrals are not subject to the 25% limit and catch-up contributions are not included in the $61,000 limit.
Set up and Contribution Deadline
Unlike the Traditional IRA or Roth IRA for individuals (which have a specific contribution deadline, generally April 15), SEPs are different. The deadline for establishing and contributing to a SEP IRA depends on when your business files its income tax returns.
The deadline for setting up a SEP IRA is April 15 or your business’ tax-filing deadline including extensions.
How Do I Open a SEP IRA?
Opening a SEP IRA requires that you put in place a written agreement to provide benefits to all eligible employees. The agreement must contain the name of the employer, what’s required for employee participation, the signature of a responsible official and a definite allocation formula. Many brokerages require you to have an Employer Identification Number (EIN) to open a SEP IRA.
You may be able to use the IRS’s model SEP plan document, Form 5305-SEP, unless one of the following situations applies:
• You maintain any other qualified plan, like a 401(k) or SIMPLE IRA
• You use the services of leased employees
• You want to use a non-calendar plan year
• You want to use an allocation formula that takes into account Social Security contributions you made for your employees
You may set up a SEP IRA with a bank, insurance company, mutual fund company or other financial institution that offers IRA accounts. You must apply to open the SEP, and each eligible employee must also submit an application.
A SEP can be established any time before a company’s annual tax filing deadline and can be used to make contributions for that tax year. For instance, if a sole proprietor’s tax deadline is April 15, 2022, to file taxes for tax year 2021, they may establish a SEP IRA anytime prior to that date and make 2021 contributions.
If there are eligible employees, employers must provide them with disclosures about the plan and allow them to enroll. This is true on a rolling basis: Once an employee becomes eligible, they must be informed. Each employee should receive a copy of the agreement containing participation rules and a description of how employer contributions may be made to the IRA, along with a copy of the completed Form 5305-SEP and a yearly statement showing any contributions to the plan.
Participating in a SEP Plan
A qualifying employee is someone who meets the following requirements:
- The employee has reached age 21
- An employee has worked for the employer for at least 3 of the last five years
- During the year, the employee received at least $650 from my employer for 2021.
An employer can exclude the following employees from a SEP or SARSEP:
- Employees covered by a union contract and whose retirement benefits were negotiated in good faith by the union.
- Employees who are nonresident aliens and do not derive their pay, wages, or other personal services compensation from their employer
Who can use a SEP IRA?
Any employer, from a sole proprietor up through a corporation, can establish a SEP plan for its employees. Those high annual contribution limits (and the fact that they’re easy to establish — more below) make them a really great choice for armies of one — freelancers, contractors, and other self-employed people — or those with very few employees.
They’re typically not as great a choice for companies with a bigger team. With a SEP, the employer has to make the same contribution to every single employee’s account. That means if a business owner wants to put in the full 25% of her earnings for herself, she also has to contribute 25% of each of her employees’ earnings for them. That can get expensive. So keep that in mind if, for example, you think your company will grow quickly. Unless a company’s looking to offer especially generous benefits in order to reduce turnover, it’s an uncommon choice.
But no matter how many employees a company has, anyone who’s 21 years old, earns at least $600 a year, and has worked for the company in three out of the previous five years is eligible to get SEP contributions. But you can make these requirements less restrictive if you want.
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