A Simplified Employee Pension (SEP) plan provides business owners with a simplified method to contribute toward their employees’ retirement as well as their own retirement savings. Contributions are made to an Individual Retirement Account set up for each plan participant (a SEP-IRA).
The contributions you make to each employee’s SEP-IRA (including your own) each year cannot exceed the lesser of:
- 25% of compensation, or
- $53,000 (for 2015 and 2016 and subject to annual cost-of-living adjustments for later years).
These limits apply to contributions you make for you or your employees to all defined contribution plans, which includes SEPs. Compensation up to $265,000 in 2016, of an employee’s compensation may be considered.
Remember that the amount you can contribute annually is limited by the IRS, and you must contribute the same percentage of compensation for all eligible employees as you contribute for yourself.
If you have no employees and just have self-employment income, you must base your contributions on “earned income.” For self-employed individuals,
earned income refers to net business profits derived from the business, reduced by a deduction of one-half of your self-employment tax, less your SEP IRA contribution.
Remember, the maximum SEP-IRA contribution for 2016 can't exceed $53,000, regardless of how much you earned.
If you have employees, the calculation is easy -- simply multiply the total compensation by 0.25. For example, if one of your employees earns $50,000 this year, you can contribute up to $12,500 to their SEP-IRA on his or her behalf.
Contributions must be made in cash; you cannot contribute property.
SEP-IRA plans have several benefits for small business owners to save for retirement, such as:
- SEP-IRA plans are easy to establish and maintain.
- Contributions are flexible - it's easy for employers to increase, decrease, or suspend contributions, as long as all employees receive an equal contribution rate.
- Contributions are made on a tax-deferred basis.
- Employees are always 100% vested in their accounts.
- Contributions can be invested in any stocks, bonds, or funds.
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