Prev Article
Next Article

Planning with a Simplified Employee Pension (SEP) IRA

07.16.24 // Markets & Investing // Blog Article //

Written by Carson Hamill CIM®, CRPC®, Associate Portfolio Manager & Assistant Branch Manager & Dean Moro BComm, CIM®, Associate Portfolio Manager

A Simplified Employee Pension (SEP) plan provides business owners with a simplified method to contribute toward their employees' retirement as well as their own retirement savings. This can be a great retirement planning tool, and in this blog, we will cover what you need to know.

What Is a SEP IRA?

A SEP IRA is a retirement savings plan designed for self-employed individuals and small business owners. It allows a business to make tax-deferred contributions to an individual retirement account (IRA) for each of its employees.

Key points:

  • SEPs are funded by the employer using tax-deductible money
  • Unlike some other retirement plans, SEP IRAs do not offer Roth or after-tax contributions
  • Employers can contribute up to 25% of each employee's annual compensation
  • Self-employed individuals can contribute up to 25% of their net self-employment earnings
  • The maximum contribution for 2023 was $66,000, and for 2024, it is $69,000 per participant

Contributions an employer can make to an employee's SEP-IRA cannot exceed the lesser of:

  1. 25% of the employee's compensation, or
  2. $69,000 for 2024 ($66,000 for 2023, $61,000 for 2022 and $58,000 for 2021)

Why an Employer/ Business Owner Might Choose a SEP IRA

A Simplified Employee Pension Individual Retirement Account (SEP IRA) offers several advantages for both employers and employees, making it a popular choice for small businesses and self-employed individuals:Tax Deductions: Contributions made by employers to SEP IRAs are tax-deductible. This means that the business can reduce its taxable income by contributing to its employees' retirement accounts.

High Contribution Limits: SEP IRAs allow for relatively high contribution limits. Employers can contribute up to 25% of each eligible employee's compensation, up to a certain limit (for 2024, it's $69,000). This can help both employers and employees save substantial amounts for retirement.

Flexible Contributions: Employers are not obligated to contribute every year. They can choose how much to contribute each year, which can be especially beneficial for businesses with variable income. However, it is important to note that the employer must contribute equally for all eligible employees.

No Employee Contributions: Employees are not required to contribute to their SEP IRAs. The responsibility for funding the account lies with the employer, although employees can make their own contributions to traditional IRAs separately.

Tax-Deferred Growth: Like other IRAs, investments within a SEP IRA grow tax-deferred. This means that the earnings on investments aren't subject to annual taxation, allowing them to compound over time.

No Roth Option: While not always considered an advantage, some may see it as one. SEP IRAs do not offer a Roth component, which can simplify retirement planning for those who prefer the traditional tax-deferral method. Employees may still contribute to a Roth IRA outside of their employer SEP IRA, subject to regular limits.

Portability: SEP IRAs are portable, meaning that employees can take their SEP IRA accounts with them if they change jobs or retire.

It's essential to consider individual financial circumstances and consult with a cross-border accountant and a cross-border financial advisor to determine if a SEP IRA is the right choice for your retirement planning needs.

Can You Roll Over a SEP IRA

Yes, like other IRAs, you can roll over a SEP IRA into various retirement accounts, including:

  • A Traditional IRA
  • Another SEP IRA
  • A pre-tax 401(k) plan
  • A pre-tax 403(b) plan

You can also convert a SEP IRA into a Roth IRA on a taxable basis.

Along with other benefits, rolling over a SEP IRA provides participants with control over their investments.

What if You Already Have a Traditional or Roth IRA

You can participate in a SEP IRA even if you have a traditional or Roth IRA. Here's what you need to keep in mind:

  • Enrolling in a SEP IRA means you're covered by a workplace retirement plan, which can affect deductions for a traditional IRA based on your Modified Adjusted Gross Income (MAGI). The IRS uses your MAGI to determine your eligibility for certain deductions, credits and retirement plans.
  • Eligibility for Roth IRAs is also based on modified AGI.
  • Self-employed individuals can lower their AGI by funding a SEP IRA, possibly making them eligible for a Roth or deductible traditional IRA.
  • Self-employed individuals can contribute to a traditional IRA, Roth IRA, and SEP IRA in the same year, offering flexibility in retirement planning.

Contributing to both a SEP IRA and traditional IRA in the same year doesn't affect the total amount you can contribute, but it does impact the amount you can deduct based on your income.

Dealing with Excess SEP Contributions

Dealing with excess SEP contributions requires prompt and precise action to avoid penalties. If you contribute more than the allowed limit to a SEP IRA, you cannot carry over and deduct the excess in the following tax year. Instead, you must withdraw the excess contribution, along with any earnings on it, by the due date of your tax return (including extensions) for the year in which the contribution was made. Failure to do so results in a 6% excise tax on the excess amount each year it remains in the SEP IRA. Accurate calculation of SEP IRA contributions before finalizing them for the tax year is crucial, with the limit being the lesser of 25% of the employee's compensation or $66,000 for 2023. To navigate these rules and correct any excess contributions properly, consulting with a tax professional is essential.

Summary

With higher contribution and income limits, a SEP IRA can be an excellent retirement plan option for small business owners and qualified employees. In this blog, we discussed the key features, benefits, and considerations for self-employed individuals looking to secure their financial future. If you have questions about your SEP IRA plan, or you are considering whether a SEP IRA is right for you, please give us a call, or contact your tax professional to discuss further.

Next Steps

If you are planning on moving to Canada and need assistance with your investments, estate planning, and portfolio management, please call or email us at Snowbirds Wealth Management, as we specialize in cross-border financial planning and wealth management. We work closely with experienced cross-border lawyers and accountants to ensure you have a team behind you.

About Snowbirds Wealth Management

Gerry Scott is a portfolio manager and founder of Snowbirds Wealth Management, an advisory firm focussed on the cross-border market. Together with Dean Moro and Carson Hamill, associate portfolio managers with Snowbirds Wealth Management, they provide investment solutions for Americans living in Canada, and Canadians residing in the United States. Licensed in both Canada and the U.S., they provide tailored investment solutions to minimize the tax burden when moving assets across borders.

To schedule an introductory call, please click here.

Statistics and factual data and other information are from sources RJLU believes to be reliable but their accuracy cannot be guaranteed. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities nor is it meant to replace legal, accounting, taxation or other professional advice. We are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters. The information is furnished on the basis and understanding that RJLU is to be under no liability whatsoever in respect thereof.

Raymond James (USA) Ltd. advisors may only conduct business with residents of the states and/or jurisdictions in which they are properly registered. Investors outside the United States are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this site. Raymond James (USA) Ltd. is a member of FINRA/SIPC.

Prev Article
Next Article