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About one in nine workers were self-employed in 2009, according to the U.S. Bureau of Labor Statistics. Self-employment offers schedule control and independence, but it usually lacks employer-sponsored 401(k) plans with high contribution limits and matching. For many small business owners, sole proprietors, partners, and freelancers, a SEP IRA (Simplified Employee Pension) is a useful alternative for retirement saving.
Roth and traditional IRAs are well known and give individuals tax-advantaged ways to save, but their contribution limits are relatively low. A SEP IRA lets eligible business owners save more and grow money tax-deferred. Employers also benefit because SEP contributions are tax-deductible.
With a SEP IRA, an employer can contribute up to 25 percent of each eligible employee’s salary, subject to an annual cap ($51,000 in 2013). Employers can make these contributions even when they are also the employee. Because SEP contributions are discretionary, you can choose to contribute in one year and skip the next without penalty.
An individual sets up a SEP IRA at a brokerage—many discount brokers offer SEP accounts—and the plan follows the same rules as a traditional IRA. That means required minimum distributions begin at age 70½, and withdrawals before age 59½ generally incur a 10 percent penalty, with certain exceptions.
For example, a sole proprietor earning $80,000 could make a tax-deductible SEP contribution of 25 percent, or $20,000—far more than the $5,500 contribution limit for a regular IRA. The IRS provides guidance on choosing and establishing a SEP IRA, and resources like Investopedia outline contribution and distribution rules in detail.
As entrepreneurship grows, SEP IRAs offer an underappreciated way for self-employed people to increase retirement savings and build long-term wealth. Have you considered a SEP IRA for your retirement plan?
