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Understanding SEP IRAs: A Guide by O1ne Mortgage

At O1ne Mortgage, we are committed to helping you navigate your financial future. If you have any mortgage-related needs, feel free to call us at 213-732-3074. In this article, we will explore SEP IRAs, their benefits, and how they can be a valuable tool for business owners and self-employed individuals.

What Is a SEP IRA?

A Simplified Employee Pension (SEP) IRA is a tax-advantaged retirement account designed for business owners and self-employed individuals. It allows employers to contribute to their employees’ retirement funds, as well as their own. Contributions to a SEP IRA are tax-deferred, meaning they can be deducted on tax returns, and distributions are taxed as regular income upon withdrawal during retirement.

SEP IRA Contribution Limits

For 2023, the maximum contribution to a SEP IRA is $66,000 or 25% of compensation, whichever is less. The compensation limit is $330,000. In 2024, these limits increase to $69,000 and $345,000, respectively. These limits are higher compared to other types of IRAs, making SEP IRAs an attractive option for business owners and self-employed individuals.

SEP IRA Rules

Setting up a SEP IRA involves some specific rules:

• Each employee must have an individual SEP IRA account.
• All contributions are made by the employer; employee contributions are not allowed.
• The contribution rate must be consistent for all eligible employees.
• Contributions can vary annually and must be made by the company’s tax filing deadline.

Who Can Establish a SEP?

Businesses of any size, including sole proprietors, partners, corporations, and nonprofits, can set up a SEP IRA. Self-employed individuals who are their own sole employees are also eligible.

Eligible Employees

Employees must meet the following criteria to be eligible for a SEP IRA:

• Age 21 or older
• Worked for the employer for at least three of the past five years
• Not covered by a union agreement
• Received at least $750 in compensation

Tax Deductions for Contributions

Contributions to a SEP IRA are tax-deductible, including those made to employees’ accounts. The maximum deductible amount is the total contributions or 25% of compensation, whichever is less. Employees can exclude these contributions from their gross income, and they are not subject to federal tax withholding, Social Security, Medicare, or federal unemployment taxes.

Vesting and Income Taxes on Distributions

Contributions to SEP IRAs are always fully vested, meaning the funds are immediately accessible. Withdrawals are subject to income taxes, and an additional 10% tax applies to early withdrawals if you are under 59½ years old.

Pros and Cons of SEP IRAs

Pros

• Higher contribution limits compared to traditional IRAs and Roth IRAs
• Fewer complicated rules and filing requirements than 401(k) plans
• Flexible contribution amounts that can vary annually

Cons

• No Roth option available
• Employee contribution rates must be equal to the employer’s rate
• All contributions are made by the employer; employees cannot contribute

How to Open a SEP IRA

To set up a SEP IRA, follow these steps:

1. Adopt a formal written agreement using one of the following methods:
   • Complete and sign Form 5305-SEP
   • Select an IRS-approved prototype SEP from a financial institution
   • Create your own SEP plan document
2. Provide each eligible employee with information about the SEP IRA plan.
3. Open a SEP IRA for each eligible employee through a brokerage firm, bank, credit union, or insurance company.

Ensure that you set up and fund your SEP IRA by the due date for your business’s income taxes to deduct contributions on your tax return. Future contributions are also due on tax day.

The Bottom Line

SEP IRAs offer a straightforward way to make tax-deductible contributions with high IRS contribution limits, benefiting both business owners and their employees. For solo business owners and entrepreneurs, SEP IRAs are worth considering as a retirement plan option. For any mortgage-related needs, don’t hesitate to call O1ne Mortgage at 213-732-3074. We’re here to help you secure your financial future.

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