These big retirement accounts are getting even bigger in .
Millions of workers have access to 401(k) plans at work. But often, smaller businesses don't have the
capacity to have a plan that's as complex as a 401(k). For them, SEP IRAs can be a great choice that
offers many of the same benefits without all the administrative hassle that a 401(k) plan entails.
Every year, the amount that one can contribute to a SEP IRA goes up with inflation, and recently, the IRS
announced that SEP participants would be able to set aside $1,000 more during 2020 than they were able to save
in 2019. With a simple yet effective approach, SEP IRAs deserve a closer look among companies that think they
can't give their workers a retirement plan.
Here's what's happening in to SEP IRA limits
The biggest advantage of SEP IRAs is that they let employers make huge contributions toward their workers'
retirement savings. SEPs can get set up to contribute up to 25% of salary up to an annual maximum, and that
amount is going up in 2020. Maximum contributions are $57,000 in 2020, up from $56,000 in 2019 and marking the
third straight year of annual increases.
Self-employed workers are also allowed to use SEP IRAs, but for them, the calculation of the 25% limit is a
bit more difficult. That's because the IRS forces employers to use 25% of net self-employment income, which
one must calculate after accounting for the reduction in income from the SEP contribution as well as
for other obligations such as self-employment taxes. The net impact is that contributions for self-employed
individuals are generally limits to a number that's slightly less than 20% of original gross income before
accounting for the reductions.
Why SEP IRAs are worth a closer look
401(k) plans are complicated, and that keeps many small businesses from ever pursuing them. With so many
administrative and regulatory requirements, having a 401(k) can be a full-time business. By contrast, SEP
IRAs-short for Simplified Employee Pension Individual Retirement Arrangements -- don't have all of the
obligations that 401(k) plans entail. The clearest example comes when you form an SEP IRA. All it takes is a
single form for the IRS, and that's far less than the pages and pages of plan adoption agreements and related
material that employers of all sizes have to look through in order to set up a 401(k) or similar retirement
plan.
It's also easier for small employers and self-employed people to find help with an SEP IRA. Most financial
institutions have streamlined procedures to open SEP IRA accounts. Moreover, once money's in the account, it's
typically easier to invest, with financial institutions giving their clients a wide range of investments from
which to choose and shape a retirement portfolio.
The biggest drawback of a SEP IRAs
The largest difference between SEP IRAs and most other retirement plans is that all of the contributions for
a SEP IRA come from the employer. Most of the time, employees are the ones making the lion's share of
retirement contributions, with employer matching or profit sharing contributions being relatively small.
Because employee contributions aren't allowed, catch-up contributions aren't given to those 50 or older
either. Unless an employer is truly committed to making the most of an SEP IRA, it can be frustrating for
workers who really want to max out their retirement savings.
That's a big reason so many self-employed workers use SEP IRAs. Because the self-employed person is both
employer and employee, it makes no difference which one the IRS requires you to make. Yet here, too, there's a
downside: If you want to make a contribution on your own behalf as the business owner, then you have to make
the same percentage contribution on behalf of any employee you have. Put another way, you're not allowed to
discriminate against other workers for your own benefit. The only exception is that you don't have to allow
new workers into the plan until they've worked a minimum amount of time.
Is a SEP IRA right for you?
SEP IRAs aren't for everyone, but if you want to save as much as you can, they have some definite value. If
putting aside $56,000 to $62,000 in a tax-favored retirement account sounds good to you, then look to see how
SEP IRAs might help you reach your financial goals.
