Simplified Employee Pension Plan - How to Open a SEP IRA

Tuesday, May 4, 2021 | Melissa Brock
How to Open a SEP IRA

I just took the leap to become a self-employed individual. Now "retired" from the corporate world, I knew all along that I'd have to switch out my 401(k) to an IRA. I no longer have the advantage of the employee match (doggone it!) and now my thoughts have turned to how to save for retirement on my own. 

I might tap into a tax-advantaged retirement account called a Simplified Employee Pension plan, or SEP IRA. My research shows that SEP IRAs can offer a boon for self-employed people or small-business owners with few or no employees.

What's a SEP IRA and what do you need to know before you open this type of retirement account? Let's dig in.

What is a SEP IRA?

The SEP IRA lets employers (individuals, sole proprietors, and small business owners) contribute to traditional IRAs set up for employees. 

The SEP IRA offers a tax-advantaged retirement savings account — a great option for both employers and employees.  

How Do I Open a SEP IRA?

Half the challenge involves getting started, just like with anything. However, you can open a SEP IRA just about as easily as buying a single stock. Let's make it super simple and distill it into just three steps:
  1. Go to your already existing broker's website or call your broker to open a SEP IRA.
  2. Draw up a written agreement to provide benefits to all eligible employees with the IRS Form 5305-SEP
  3. Work with your broker to set up a SEP IRA account for each eligible employee. 

How a SEP IRA Works

How do Traditional IRAs and 401(k)s differ from a SEP IRA? It functions very much the same. The only really huge difference involves the fact that a SEP IRA benefits self-employed people or small business owners. 

A SEP IRA grows tax-deferred until retirement. This means that when you take money out of the account when you retire, your money gets taxed as income. You can begin to make withdrawals from your SEP IRA account when at 59 ½.

What happens if you decide you need your money before age 59 ½? You may have to pay a 10% early withdrawal penalty fee. However, as with most things, you can find exceptions to the rule. If you plan to buy your first home or pay for certain college expenses, you can use SEP IRA money to pay for those things. 

SEP Contributions and Limits

As you add money, take note of the limits. You can rack up to $58,000 in your SEP IRA in 2021. However, annual contribution limits cannot exceed 25% of compensation or $58,000 in 2021 — whichever is less.

Advantages of a SEP IRA

The biggest advantage of a SEP IRA involves its high contribution limits — if you can swing it, $58,000 annually can make a huge impact on your retirement portfolio. Other major advantages include its other winning features: 

  • Tax deductible
  • Tax-deferred until retirement
  • Can combine with a Roth IRA or a Traditional IRA (just take note of the income ceilings)

Disadvantages of a SEP IRA

Make sure you know the disadvantages of a SEP IRA before you choose a SEP for your employees and yourself. 

  • Immediate vesting: Immediate vesting works great for employees, but as an employer, it might not work out so well. Why not? Let's say a new employee signs up for your SEP plan, then leaves after six months. They get to take the portion of funds you contributed when they leave because of immediate vesting.
  • No catch-up contribution option: Those 50 and older can't take advantage of a catch-up provision within the SEP IRA like they can with a 401(k).
  • No Roth version: The SEP IRA doesn't offer a Roth version. In other words, you can't make contributions now, then take your money out tax-free in retirement. 

Employee Eligibility Requirements

Employee eligibility requirements: For those who have employees, you must contribute on your employees' behalf and employee contributions must equal your own contribution percentages. The short explanation: When you invest 10% of your own income into a SEP IRA, you’ll also contribute 10% into your employees' SEP IRAs as well. 

Other eligibility requirements for employees: Employees must have passed their 21st birthday, worked for your business during three of the past five years, and earned at least $650 in the past year in 2021. Check out more requirements through the IRS

Look into an SEP IRA Today!

Among those plans for the self-employed or small-business owners: an IRA (traditional or Roth), a Solo 401(k), a SEP IRA, a SIMPLE IRA or a defined benefit plan. One of the biggest benefits among several of those plans involves the opportunity to save way more than with 

Which one works best for you? Carefully consider which type of retirement savings option meets your needs, your employees' needs and more. Finally, consider your age, current income and risk tolerance. Consult with a financial advisor if you're really not sure which one will benefit you the most. 

As for me, I'm still deciding which type will work best for me — that is, beyond my Roth IRA.

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