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A SEP IRA is an employer-sponsored retirement account. Bankrate explains.

What is a SEP IRA?

A Simplified Employee Pension Individual Retirement Account, or SEP IRA, is a tax-deferred retirement savings account for small businesses and the self-employed designed to let an employer build a retirement arrangement for herself and her workers with ease. As of 2017, an employer can contribute up to 25 percent of an employee’s gross wages or $54,000 per year, whichever is lower.

Deeper definition

A SEP IRA is a traditional IRA that allows employers to set up a retirement account for their employees or themselves, if they’re self-employed, with relatively little effort. Not only are there no administrative costs, but the business owner can also deduct the contributions she makes on her tax return.

As with other IRAs, SEP IRAs have annual contribution limits, but they are considerably higher than other IRAs. Employers can contribute up to 25 percent of the employee’s compensation, limited to $270,000, or up to $54,000, whichever is lesser. When the account holder is self-employed, there is not a set contribution percentage; she must calculate her annual contribution limited based on the rate tables provided Internal Revenue Service (IRS).

The IRS requires that eligibility be nothing more strict than the following:

  • Those over age 21.
  • Those who have earned at least $600 from the employer during the year.
  • Those who have worked for the company for at least three out of the past five years.

The rules might vary from plan to plan or based on an employer’s preference, such as opening the plan to younger employees or those who have worked for the company for a shorter time than three out of five years. Contributions to a SEP IRA must be paid in cash or the equivalent and the IRS requires that employers make the same allocation percentage for each salary.

Don’t have a SEP IRA with your employer? Check out the rates on a certificate of deposit instead.

SEP IRA example

Carrie has five employees at her small business. She wants to make sure they’ll taken care of in retirement, so she establishes a SEP IRA and makes contributions to it. She now contributes 3 percent per each employee’s salary to that employee’s individual retirement account, and she can write off that amount on her tax returns each year.

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