In this article
How To Get Started With A SEP-IRA
A Simplified Employee Pension (SEP) IRA is an employer-sponsored retirement savings plan for self-employed individuals and small business owners.
It allows employers in the gig economy to establish a retirement plan through which they can contribute to their own and eligible employees’ retirement on a tax-free basis.
While SEP-IRAs have the same investment options as traditional IRAs, they have much higher annual contribution limits than traditional IRAs that makes it attractive to freelancers.
As of 2020, you can contribute up to the lesser of 25% of your compensation for the year or $57,000 ($58,000 in 2021).
The amount of compensation you can use to calculate the 25% is limited to your business’s profits up to $285,000 in 2020 ($290,000 in 2021).
How to Set up a SEP-IRA
Sole proprietors, partnerships, corporations, or anyone who earns an income through their products & services can establish a SEP-IRA.
Appropriately enough for contractors, freelancers, drivers and other gig economy workers, setting up a SEP-IRA is a pretty DIY process.
Steps to Open an Account
As with many other employer plans, the deadline for contributions is the tax filing deadline (plus extensions) of the business that sets up the SEP-IRA. However, you can only open an account in the calendar year you’re contributing to. So for 2020, you have to open an account before December 31, 2020 in order to count your contributions towards tax year 2020.
- Adopt a formal written agreement by signing an IRS model SEP-IRA using Form 5305-SEP, an IRS-approved prototype SEP-IRA, or an individually designed SEP-IRA plan document.
- Inform each eligible employee about the SEP-IRA.
- Set up a SEP-IRA for each eligible employee with a qualified financial institution.
The plan trustee or account provider can help you with all of the set-up steps above. If it’s not clear to you, email us and we’re happy to help.
SEPs are easy to set up and have low administrative costs. They were designed to encourage retirement benefits among businesses that would otherwise not establish employer-sponsored arrangements.
In this arrangement, the business owner or employer makes contributions to individual retirement accounts set up for each employee (including the owner). They can then claim an IRA tax deduction for the contributions that are made.
Bear in mind that contributions apply to any employees that are over 21 years old and have worked for your business in at least 3 of the previous 5 years (this is called the 3 of 5 eligibility rule). They must have also received a minimum of $600 in compensation in 2020 ($650 for 2021).
Because SEP-IRAs vest immediately, the employee owns the funds in the SEP-IRA from day one. Employers have the authority to exclude certain types of employees from qualifying in a SEP-IRA.
SEP-IRA contributions are discretionary. As a business owner, you are not required to contribute to a SEP-IRA each year. Also, there’s no set amount that you have to put in.
Since SEP is a traditional IRA, it is subject to the same distribution and rollover rules as traditional IRAs.
If you are self-employed, figuring out how much you can contribute every year can be somewhat tricky. Lucky for you, our retirement calculator can help you determine how much you should contribute.
Popular Financial Institutions to Consider
Generally speaking, most major banking/lending institutions have this retirement option. If you’re already satisfied with the banking institution that you use, it’s probably worth asking if they offer a SEP-IRA. This way you can keep everything under one roof. However, if you’re looking for a few other places to get started we’ve highlighted a few of the most popular below:
| Company | Fees | Investment Options | Unique Features |
|---|---|---|---|
| Charles Schwab | No fees for account opening, annual maintainence, and trades. No minimum to open | Common stock market options | 24⁄7 support with educational materials and retirement planning advisors |
| Betterment | 0.25% per year on your invested balance | Common stock market options, and a Socially Responsible Investing option | Robo-advisor that rebalances portfolio for you, only available to those with no employees |
| *M1Finance | No account minimum, or management fee. Pay $125 per year for a premium version | Common stock market options | Robo-advisor that lets you play a hand in your retirement investments |
| E-TRADE | No account minimum and $0 trading fees | Common stock market options | You can have several accounts with the same broker. |
* Disclaimer: These partners pays us an affiliate income if you open an account with them. Read our promise and advertising disclaimerfor details
Pros and Cons of SEP-IRA
| Pros | Cons |
|---|---|
| Easy to set up and administer | No Roth option and no catch-up contributions. |
| You can make bigger contributions than traditional and Roth IRAs. And you can combine it with a traditional or Roth IRA. | Employers provide retirement benefits to their employees at a higher cost compared to the SIMPLE-IRA, since the SEP-IRA has to match whatever the owner’s retirement benefit is up to 25% while the SIMPLE-IRA matches up to 3%. |
| The money in a SEP-IRA is not taxable until withdrawal. | Withdrawals before the age of 59 ½ may be subject to a 10 percent tax penalty. |
| Employer contributions are vested immediately. |
Summary
If you are self-employed and wondering how to contribute to a tax-advantaged retirement plan, a SEP IRA is a flexible and cost-effective way to grow savings tax-deferred and enjoy financial security.
While it may be convenient to set up a SEP IRA, consider consulting your tax professional to ensure that the plan suits your business profile.
It's not easy to get started as a freelancer, and our aim is to help all freelancers build a retirement plan. If you’re interested in reading more, please subscribe below to get new articles & actionable tips on how to stop overpaying taxes and start building financial security!
