October 29, 2023

Small Business SEP IRA Guide (2024): Set Up, Contributions, & FAQs

Contents

A SEP IRA, or Simplified Employee Pension Individual Retirement Account, is a retirement savings plan for small business owners and their employees. 

Unlike traditional IRAs, which have an annual maximum contribution limit that’s set by the IRS, SEP IRAs allow for contributions based on net business income, which can result in a larger annual contribution.

SEP IRA contributions are tax-deductible and the invested contributions grow tax-deferred, meaning investment income won’t be taxed until you make withdrawals during retirement. 

The large contribution limits combined with the dual tax benefit can make SEP IRAs a smart financial move. However, the setup and annual contribution process can be complicated, which is why I wrote this guide for small business owners interested in setting up a SEP IRA but not sure where to begin.

Small Business SEP IRA Rules: Deadlines & Maximums

Here are the basic SEP IRA requirements that you need to know.

Setup & Contribution Deadlines

You must set up and contribute to the SEP IRA before your business's tax return due date, factoring in extensions.

Here are the SEP IRA deadlines by entity type:

  • Partnerships (Form 1065): March 15th, 2024
  • S Corporations (Form 1120-S): March 15th, 2024
  • Corporations (Form 1120): April 15th, 2024
  • Self-Employed Individuals (Schedule C): April 15th, 2024

If an extension has been filed, the business has an additional six months to set up and contribute.

SEP IRA contribution limits

For 2023, the maximum that your business can contribute to an employee’s SEP IRA is the lesser of:

  • $66,000; or
  • 25% of employee compensation.

Keep in mind that contribution rates must be the same for all employees. If you’re contributing 25% of compensation for yourself, then you’d need to also contribute 25% of compensation to all eligible employees.

For calculation purposes, employee compensation includes wages, salaries, tips, overtime, bonuses, commissions, vacation, sick pay, and other taxable compensation. Compensation doesn't include severance pay, nontaxable fringe benefits (such as employer paid health insurance), or worker’s compensation.

Contribution limit for sole proprietors

The calculation for self-employed business owners (i.e. those filing on Schedule C) differs from the 25% limit applicable to other business filers. In this case, the calculation is based on net self-employed income after deducting the SEP IRA contribution and 50% of self-employment taxes.

As a self-employed individual, you can calculate your maximum SEP IRA contribution using the tables and worksheets in IRS Pub. 560.

First, determine the SEP IRA contribution rate, as a percentage of compensation, you’d like to contribute for yourself and all employees, if you have any. The rates must be the same for everyone.

Then find the applicable rate in column B of the ‘Rate Table for Self-Employed’ in Pub. 560 and complete the ‘Deduction Worksheet for Self-Employed.’ The result is your maximum SEP IRA contribution for the year.

In short, if you intend to make the maximum contribution as a self-employed individual, your contribution equals 20 percent of net self-employment income after deducting 50% of self-employment taxes and the entire SEP IRA contribution.

Small Business SEP IRAs: Where to Start

Choosing an administrator for your business’ SEP IRA is the first step, and it sets the stage for how your business manages its SEP IRA plan moving forward. Here are some common administrators:

  1. Schwab - A powerhouse in the brokerage world, known for its research and vast investment choices.
  2. Vanguard - Renowned for its low-cost index funds and investor-friendly approach.
  3. Fidelity - A well-rounded provider with diverse investment options and user-friendly tools.
  4. Guideline - A modern platform catering especially to small businesses, with automated features.

Key Considerations When Choosing a SEP IRA Administrator

Before diving in, evaluate the costs. Review account setup fees, annual maintenance charges, and any trading fees. Some platforms might offer a low-cost or even no-fee approach, but confirm there are no hidden charges.

Choosing the right SEP IRA administrator isn't just about cutting costs; it's about simplifying the management process. Check the ease of administrative tasks like setting up the account, adding contributions, or rolling over funds. If a platform provides automated features or dedicated support, that’s a plus.

The breadth and quality of investment choices matter. While some might prefer a platform with a wide array of stocks, bonds, and funds, others might lean towards those specializing in index or mutual funds.

Setting Up a SEP IRA: Step-by-Step Guide

Once you’ve selected the plan’s administrator, here's how the set up process goes:

Documentation Submission

You’ll need to provide the administrator with a signed SEP IRA Adoption Agreement. This document establishes the ground rules, detailing key provisions like the plan's effective dates, employee eligibility, and contribution formulas. To ensure you're on solid footing, it's wise to consult a tax advisor well-versed in SEP IRA when preparing this document.

Next, sign the Employer's Agreement, which acts as a contract between your business and the administrator, specifying the terms of service and setting expectations for both parties.

You should save both documents for future reference, as they’ll be important when determining which employees are eligible for annual SEP IRA contributions among other things.

Employee Communication and Guidance

When you’ve set up the SEP IRA plan, you’ll then need to advise employees on opening their individual SEP IRA accounts. Provide them with an overview of SEP IRAs, covering the benefits, rules, fees, and features. The administrator may provide brochures and other literature to help educate employees.

Employee Account Setup

After informing employees of the plan, you’ll then make available the application forms that employees will use to open their individual SEP IRA with the administrator. Once applications are submitted and accepted, collect them for review. You may need to reference the account numbers later on when making contributions.

Instead of employees opening their SEP IRAs, the administrator may allow the employer to open the accounts on their behalf. The account still belongs to the employee, even if they didn’t open the account.

Administering the SEP IRA: Enrollment & Contributions

Setting up a SEP IRA is just the beginning. You’ll then need to maintain it on an annual basis, by enrolling new employees and making contributions in accordance with IRS rules.

Enrolling New Employees

When making annual contributions to the SEP IRA plan, you’ll need to determine which employees are eligible based on the provisions in your company’s Adoption Agreement. 

Once you’ve confirmed an employee’s eligibility, promptly notify them and provide comprehensive plan information, detailing the nuances and benefits of the SEP IRA and steps to open their account. You can open an account for them, if the SEP IRA administrator allows for it.

Making Contributions

The contribution process is twofold. 

Start by calculating the contribution amounts for each employee. This entails determining each employee's total compensation and then applying the fixed percentage or formula that you've established for the year’s contribution. 

Remember the pro-rata rule when making contributions, which requires the contribution percentage or formula to be applied consistently to all employees. For example, this means that you can’t apply a 10% contribution rate to one employee’s compensation and a 20% rate to another employee’s compensation. You’d need to use 10% for all employees.

Once the contribution amounts are calculated, make the contribution by sending funds to the SEP IRA administrator. 

The funding process depends on the steps established by the administrator. You may need to write a check with an attachment that specifies the allocations to each employee’s SEP IRA account, or you might be able to fund a contribution electronically.

When to Consult a Professional

Setting up and maintaining a SEP IRA plan takes time and a bit of expertise. If you’re not familiar with the rules or don’t have the time to spare then it might be worth reaching out to a tax advisor who’s knowledgeable about the SEP IRA and other small business retirement plans. They can help you avoid common pitfalls and adverse consequences with the IRS, while saving you time.

Small Business SEP IRAs: FAQs

Does a SEP IRA contribution have to be deducted in the year it was deposited in employee accounts?

No, a business can deduct a SEP IRA contribution even if the contribution was deposited in the following year. For example, if the business calculates a SEP IRA contribution based on its 2023 employee compensation, but it funds employee SEP IRAs in March 2024, it can still deduct the amount on its 2023 tax return. See IRC Section 404(a)(6)

Does a SEP IRA contribution need to be deposited before filing the employer’s tax return?

No, a SEP IRA contribution doesn't need to be deposited before filing the employer’s tax return. However,  in order to deduct the contribution, it should be fully paid by the company’s tax return due date, factoring in any extensions. 

Where do I deduct SEP IRA contributions on Schedule C of Form 1040?

SEP IRA contributions made for your employees should be deducted on Line 19 (“Pension and profit-sharing plans”) of Schedule C. SEP IRA contribution for yourself as a sole proprietor should be deducted separately on Line 16 (“Self-Employed SEP, SIMPLE, and Qualified Plans”) of Schedule 1 of Form 1040

Where to deduct SEP IRA contributions on Form 1120-S?

If you operate an S corporation and make SEP IRA contributions for employees, these contributions are deductible on Line 17 (“Pension, Profit-Sharing, etc. Plans”) of Form 1120-S.

Where to deduct SEP IRA contributions on Form 1120?

For C corporations making SEP IRA contributions, these contributions can be deducted on Line 23 (“Pension, Profit-Sharing, etc. Plans”) of Form 1120.

Where to deduct SEP IRA contributions on Form 1065?

Partnerships that contribute to SEP IRAs for employees deduct their contribution on Line 18 (“Retirement Plans, etc.) of Form 1065. Contributions to a partner’s SEP IRA should be reported on Box 13 of the partner’s Schedule K-1.

Does a SEP IRA contribution go on on W-2?

No, SEP IRA contributions made by an employer do not get reported as taxable income on an employee's Form W-2. Thus, you won't see them in the wages, tips, or other compensation boxes. However, the employer should indicate the presence of SEP contributions in Box 13 of the W-2 by checking the "Retirement plan" checkbox.

This content is for informational purposes only and does not constitute legal, business, or tax advice. You should consult your own attorney, business advisor, or tax advisor regarding matters mentioned in this post. We take no responsibility for actions taken based on the information provided.

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