RETIREMENT READ TIME: 4 MIN
Understanding SEP-IRAs for Small Business Owners
What Is a SEP-IRA?
For many small business owners, managing daily operations can leave little time to plan for retirement. A Simplified Employee Pension Individual Retirement Arrangement (SEP-IRA) is a retirement plan designed for small businesses, including sole proprietors, partnerships, and corporations (including S corporations). It provides a flexible way to contribute toward retirement for both owners and employees.
Contribution Flexibility
One of the main features of a SEP-IRA is the flexibility in contributions. Employers can contribute anywhere from 0% up to 25% of an employee’s compensation, with a maximum contribution of $72,000 in 2026. Contributions must be consistent for all eligible employees, which helps ensure fairness across your team.
Eligibility and Vesting
Eligible employees are generally those who are age 21 or older, have worked for the business for at least three of the last five years, and have earned $750 or more during the year. Contributions to a SEP-IRA are immediately 100% vested, meaning employees have full ownership of the funds.
Simplified Administration
SEP-IRAs are designed to minimize administrative burdens. There are no annual filings required with the IRS. Employers need only complete Form 5305-SEP and keep it on file. Copies of the form should be provided to employees as they become eligible for participation.
Unlike other retirement plans, a SEP-IRA can be established as late as the tax filing deadline for the prior year, including extensions. This can provide flexibility for small business owners who make decisions late in the year.
Employee Investment Choices
Each eligible employee establishes their own SEP-IRA account and manages the investments within that account. This approach reduces administrative responsibilities for the employer while giving employees control over their investment choices. Access rules for SEP-IRA funds follow the same guidelines as traditional IRAs.
Withdrawals and Required Minimum Distributions
Generally, withdrawals from a SEP-IRA are taxed as ordinary income. If funds are withdrawn before age 59½, a 10% federal penalty may apply, though certain exceptions exist, such as death or disability. Once an individual reaches age 73, required minimum distributions (RMDs) must begin.
It is important to note that unlike some other plans, SEP-IRAs do not allow loans from the account. Understanding these rules helps business owners and employees plan for long-term retirement income.
Comparing SEP-IRAs with Other Plans
SEP-IRAs differ from other retirement options, such as self-employed 401(k) plans. While a 401(k) may allow loans, SEP-IRAs focus on simplicity and flexible contributions for both employers and employees. This makes them a practical choice for small businesses seeking a straightforward retirement solution with minimal administrative effort.
Key Takeaways
- SEP-IRAs provide flexible employer contributions and immediate vesting for employees.
- Administration is simple, requiring only Form 5305-SEP for IRS compliance.
- Employees control their own investments, following the rules of traditional IRAs.
- Withdrawals are taxed as ordinary income and RMDs begin at age 73.
For small business owners, a SEP-IRA can offer a balance of flexibility and simplicity in retirement planning.
