One type of retirement plan that often fits the needs of small business owners is the Simplified Employee Pension (SEP). Typically, accounts are set up as SEP IRAs, much like traditional IRAs.
What to know about SEPs
As the name implies, it’s relatively simple to establish and operate a SEP plan. Unlike some other qualified plans – including 401(k)s – you don’t have to file annual reports with the IRS. Here are some other key aspects of SEPs:
- The contribution limit is generous. For 2018, the maximum deductible contribution is generally equal to the lesser of 25 percent of compensation (20 percent of earned income of a self-employed individual) or $55,000. In comparison, the annual contribution limit for a traditional IRA is only $5,500 ($6,500 if you’re age 50 or older).
- Employers make contributions. A potential downside for employers is that you generally have to make contributions on behalf of all full-time employees who are 21 and older and have worked for the business at least three of the last five years. Part-time employees are included if each earns more than $600 in 2018.
- Contributions are discretionary. For instance, you can boost them in good years, cut them or even skip them in bad years, as long as you contribute the same percentage of compensation for all participants. This gives small business owners flexibility.
- RMDs are necessary. As with other qualified plans, you must begin taking required minimum distributions (RMDs) after you reach 70 1/2. And, if you make withdrawals prior to 59 1/2, you could be hit with a 10 percent penalty tax on top of the regular income tax (unless a special exception applies).
Of course, you have other options. The qualified SIMPLE plan is similar to the SEP but offers a lower contribution limit. For 2018, the limit is $12,500 ($15,500 if you’re 50 or older). Finally, you have until your tax return due date, plus extensions, to set up and fund a SEP for the tax year.