Self-employed individuals and small business owners with excess income should consider setting up SEP IRA.
There are 7 different types of IRAs including the Traditional, Roth, SEP, Nondeductible, Spousal, SIMPLE, and Self-directed. Each IRA has its advantages and disadvantages, however for this blog post, I would like to focus on the SEP IRA.
A Simplified Employee Pension (SEP) provides a easy way for employers to make contributions for their employees' retirement as well as themselves. A SEP IRA is best for self-employed individuals or small business owners with few or no employees as it allows you to save and invest significantly more, as a tax deductible contribution, than you can with a traditional IRA.
What are the rules?
- The employers contribution cannot exceed lesser of 25% of compensation or $56,000 for 2019, subject to a $280,000 compensation cap.
- Must be a written plan (IRS Form 5305-SEP).
- Eligible employees include those that have worked 3 of the last 5 years and earned at least $600 in compensation.
- A separate SEP IRA should be setup for each eligible employee with the account provider, and
- Each eligible employee must receive information about the SEP IRA and a copy of the written agreement (Form 5305).
What are the pros and cons of a SEP IRA?
- Contribution limit of $56,000 in 2019
- Easy to setup and administer
- No requirement to contribute every year
- All contributions are tax deductible, including those made for the benefit of employees
- It's ok to combine with a Traditional or Roth IRA
- No catch-up contribution for folks 50yrs or older
- Required proportional contributions for eligible employees if you contribute for yourself (ex. 15% per employee)
- Required minimum distributions begin at age 70.5yrs
- Early distributions before age 59.5yrs are income and subject to 10% early withdrawal penalty
- Must include all eligible employees
Tips to avoid common mistakes identified by the IRS:
- Review your written plan annually, to ensure that it agrees with current law
- Review employee eligibility on an annual basis
- If you own multiple businesses, be sure to include eligible employees from those related businesses
KLSM CPA Firm PLLC is a local Houston, TX CPA firm that empowers individuals and small businesses by providing accounting and tax solutions for financial success. We also assist our clients with tax resolution matters such as sales tax, payroll and income tax issues in Houston, TX, San Antonio TX, Austin, TX and elsewhere.