An employer-sponsored retirement plan can be a great way for employers to show workers they care about employees’ long-term financial prospects while giving workers a way to save on their taxes.

A simplified employee pension (SEP) plan lets business owners and self-employed individuals use a simple way to make contributions for retirement savings. SEP-IRAs come with streamlined rules that make them less onerous to set up and administer than are 401(k) plans and more complex choices.

Let’s see how they work:

  • Employers are responsible for setting up SEP-IRAs for employees. Self-employed workers play the role of employer and employee.
  • SEP-IRAs resemble other types of traditional IRAs. Money put into a SEP-IRA isn’t included as income to the employer. (Employees themselves do not contribute unless, as noted, they are their own employers.)
  • Investments in a SEP-IRA are tax-deferred, meaning that you don’t have to pay taxes on any income or gains that those investments generate until you make withdrawals from the SEP-IRA.
  • Employers can contribute as much or as little as they want each year. There is a maximum, which usually changes each year. The current limit is 25% of an employee’s salary, up to $58,000. That’s much more than allowed for in alternatives like SIMPLE IRAs and ordinary individual retirement accounts. For high-income individuals, it’s hard to match what SEP-IRAs allow.
  • It’s easy to set up a SEP-IRA. Most financial institutions make the paperwork uncomplicated, and the IRS offers a standard form — Form 5305 — to establish a SEP-IRA.
  • But there’s one thing to keep in mind — if you’re a business owner, you generally can’t make huge contributions to your own SEP-IRA without making equal percentage contributions to employees’ SEP-IRA accounts as well.

In many ways, SEP-IRAs work just like a traditional IRA:

  • Withdrawal of funds prior to age 59½ may be subject to penalty and taxes, except in certain special circumstances.
  • You can’t borrow from a SEP-IRA as you can from many 401(k) plans.
  • You can roll your SEP-IRA assets into another IRA account.
  • You can roll assets from another retirement account into your SEP-IRA.
  • You must take required minimum distributions from a SEP-IRA beginning at age 72.

SEP-IRAs make it easier to help employees save for retirement. They have far fewer requirements than alternative pension arrangements. It could be a good move for your small business, even if you are the only employee.

However, the choice of a retirement plan at your business is an important one. The tax and financial implications can be substantial, and there may be other restrictions and provisions. Also, your decision can have a substantial effect on employee satisfaction.

Contact an MCB Advisor at 703-218-3600 or click here. To review our business planning articles, click here. To review our personal financial planning articles, click here. To learn more about MCB’s tax practice and our tax experts, click here. 

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