What is an SEP retirement plan?

A Simplified Employee Pension (SEP) plan is a way for self-employed and small-business owners to contribute toward their own and their employees’ retirements. SEP plans follow the tax-advantaged rules of traditional IRAs.   

SEP retirement plan basics

The world is becoming more entrepreneurial. Self-employed workers and small business are growing. Many are thriving. Working for yourself can be exciting and rewarding, but it can also mean that you aren’t able to get those extensive benefits packages that larger employers offer. That doesn’t mean you have to miss out on saving for retirement, however. You have options that can provide some of the same tax-advantaged benefits as an employer-sponsored 401(k).

One option is a Simplified Employee Pension (SEP) plan. It’s a tax-advantaged way for self-employed and small-business owners to help themselves and employees save for retirement. It functions similarly to a traditional IRA, but it has many special rules.

Who can set up an SEP retirement plan?

Any employer can set up an SEP retirement plan, even if the employer is self-employed. It’s an easy process. There’s a simple written agreement you need to fill out and sign. Then you set up an SEP-IRA account for each eligible employee with a bank, insurance company, or other qualified financial institution. Individual employees own and control their SEP-IRAs.

Who is eligible for an SEP retirement plan?

You and employees you pay may qualify for an SEP plan. Employees must be included if they are age 21 or older, have worked for your business in at least three of the last five years, and made at least $600 from your business during each of those years. But you can use less restrictive requirements if you wish.

How much does it cost to run an SEP retirement plan?

This is one of the main benefits of an SEP plan over traditional employer-sponsored programs. Start-up and ongoing costs can be high with a 401(k). That isn’t the case with SEP-IRAs, and that makes them an attractive option for small-business owners and self-employed workers.

Rules and limits for an SEP plan

An SEP plan follows traditional IRA tax rules and offers the same investment options. However, contribution limits are generally much higher than for a traditional or Roth IRA, and the way eligibility is defined is different. For more information and FAQs, visit the IRS.gov SEP plan page.

What are the yearly contribution limits?

The limit for each year for each employee is whatever is less: 25% of an employee’s pay or $61,000 (in 2022). 

For self-employed workers, there is a calculation you can make to determine how much you are able to contribute. It can be found on the IRS page here. 

Is there a deadline to set up an SEP plan?

If you want to set up your own SEP plan, you need to do it by your business’s income tax return deadline. If you’ve gotten an extension for your taxes, that also extends the window to set up your SEP-IRA.

What is the 3-of-5 rule?

If you have employees, the 3-of-5 rules means that you must include any eligible employee in your plan if they have worked any 3 of the last 5 years for your business. You can choose less restrictive rules, if you’d like, such as allowing employees to contribute immediately, but you don’t have to. 

What are the distribution rules and limits?

When it comes time to start making withdrawals from your SEP plan, it functions exactly the same as a traditional IRA. You can take distributions at any time, but you will owe taxes on them, and they may be subject to a 10% penalty if they are taken before age 59½. In order to realize maximum growth, it’s best to wait as late as possible before you start withdrawing from your SEP-IRA.

Can I have an SEP plan and other savings plans?

Most of the time, yes, but it complicates some of the paperwork. A few options are incompatible with SEP-IRAs. Talk to a financial services professional to fully understand your options and potential conflicts. 

Alternative retirement savings 

An SEP-IRA isn’t your only option to save for retirement if you’re self-employed. There are many ways to invest in your future. Some may replace an SEP plan, while others can act as great additions to any retirement plan you have. 

Solo 401(k)

This is a 401(k) plan designed for individuals instead of businesses. It’s sometimes called a one-participant 401(k). Contribution limits are the same as those for an SEP, but a solo 401(k) allows participants over age 50 to make additional catch-up contributions and post-tax Roth contributions. But a solo 401(k) can also come with higher running costs. We can help you crunch the numbers and see what is best for you. 

Fixed deferred annuities

With a fixed deferred annuity, you can create a stream of guaranteed income² for life. It is called an annuitization.  That makes a fixed annuity a great addition to any retirement plan. Basically, your premiums grows tax-deferred, and you receive guaranteed payments for life once you reach retirement.

Related: What is an Annuity?

Traditional or Roth IRA

While similarly structured, these savings vehicles are generally designed to be supplemental to other retirement savings. The maximum you can contribute each year is much lower than the maximum with other options.  

If you want to get started saving for retirement, whether you’re a small-business owner or self-employed, our NYLIFE Securities LLC registered representatives can help you go over all your options. Depending on your unique situation and goals, one or more savings vehicles may be right for you. Let us help you build a strategy to ensure a safe and satisfying retirement.

This material is provided for information purposes only. Neither New York Life Insurance Company, nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions. 

RELATED CONTENT

¹Jonathan Rothwell and Jessica Harlan “Self-Employment and Gig Economy Trends in the U.S.” Gallup Inc, 2019.

²Guarantees are based upon the claims paying ability of the issuing insurance company. Withdrawals may be subject to regular income tax, and if made prior to age 59 ½, may be subject to a 10% IRS penalty. In addition, surrender charges may apply.

Investments are offered through NYLIFE Securities LLC (member FINRA/SIPC), a Licensed Insurance Agency and a New York Life company.