Boasting a high contribution limit and low administrative fees, Simplified Employee Pension Plans (SEP IRAs) can help employees and the self-employed save and invest for retirement. Here's how to figure out how much you can save in your and your employees' SEP IRAs this year.
SEP IRA contribution limits for 2023
The SEP IRA contribution limit for 2023 is 25% of eligible employee compensation, up to $66,000. The maximum compensation that can be considered for contributions in 2023 is $330,000. It's important to note that employees typically cannot contribute to SEP IRAs. Instead, employers decide how much to contribute and make all contributions on behalf of their employees.
If you're self-employed, this means that on paper any contributions made to your SEP IRA are from your business, not from you as an employee of that business. As a self-employed individual, you can calculate your compensation for the purpose of SEP IRA contributions as the lesser of your net earnings from self-employment minus half of your self-employment tax and your contributions to your own SEP IRA or $330,000 in tax year 2023.
Depending on your SEP IRA plan, you (as an individual) may be able to make additional individual contributions up to the IRA contribution limit each year—which is $6,500, or $7,500 if you're over age 50, for tax year 2023—so long as your total contributions are under the SEP IRA annual contribution limit.
Keep in mind that this individual IRA contribution limit is cumulative across all IRA accounts. So, for example, if you contribute the maximum individual limit of $6,500 to your SEP IRA in 2023, you are ineligible to contribute to other IRA accounts that tax year.
Who's eligible to contribute to a SEP IRA?
Business owners can establish SEP IRAs to save for their employees' retirement, even if they are self-employed and the only employee of the business. If a business has multiple employees and elects to establish SEP IRAs, it is required to set up accounts for everyone who is eligible.
To be considered an eligible employee to receive SEP IRA contributions you must:
- Be age 21 or older.
- Meet the 3-of-5 rule, meaning you've been employed, full time (not as a contractor), by the company for any period of time during at least 3 of the last 5 years.
- Earn at least the minimum annual compensation from the SEP IRA-sponsoring employer. For 2023, this is $750.
Even if you do not meet these criteria, your employer can still contribute to your account depending on their policy, but they are not required to.
Notably, the percentage of income contributed to a SEP IRA must be the same across all employees, including the owner. There is no requirement or obligation for the business owner to make contributions each year, though, assuming they do not contribute to their own company-associated SEP IRA during that period.
Additionally, your company may exclude the following from its SEP IRA:
- Those covered by a union collective bargaining agreement for retirement benefits.
- Those who are not US residents and do not receive US wages.
What happens if your employer contributes too much to your SEP IRA?
If you or your employer overcontributes to your SEP IRA, you may be subject to taxes and penalties as excess contributions are considered part of your gross income and these contributions may be nondeductible for the business.
To avoid this, you have 3 options.
- Return the excess contributions and any earnings back to the business. If you are the business owner, you then must report this business income as taxable. The distributed amount is not considered taxable for the employee but must be reported on Form 1099-R with a taxable income of 0.
- Carry over the excess SEP contribution to a later year. Your total contribution for that year must then be below the contribution limit for that year. You may also have to pay a 10% excise tax.
- You can make a submission through the IRS's Voluntary Correction Program (VCP) and keep any excess contributions in your SEP IRA. But your plan must agree to enter into a closing agreement and pay an additional fee to the IRS.
If you or your company does not correct the mistake by the tax filing deadline, the excess contributions may be subject to costly IRS tax penalties, to the tune of 6% for the employee and 10% for the employing business.
How much should you contribute to your SEP IRA?
If you are not the business owner sponsoring a SEP IRA, you likely have no control over how much is contributed to your SEP IRA. But if you are self-employed or the owner of a small business offering SEP IRAs, you have a decision to make. Although contributions to your SEP IRA reduce your business's (or company's) tax liability and boost your and your employees' retirement savings, it may be challenging to balance today's business priorities with future savings.
As an individual, Fidelity suggests saving at least 15% of your pretax income for your retirement each year. This guideline includes contributions across all retirement accounts, including other IRAs, and 401(k)s or 403(b)s. It also includes any employer contributions to retirement plans.
SEP IRA FAQs
What is the deadline to contribute to your SEP IRA in 2023?
A SEP IRA plan for a given year must be established by the due date of the sponsoring business's income tax return for that year, with extensions if applicable. All contributions must be deposited by the same date to be considered deductible for the year.
If you have a SEP IRA, can you contribute to other retirement accounts?
Yes, you can contribute to other retirement accounts on top of your employer's contributions to your SEP IRA. If you are employed by multiple businesses, it's possible to have both a SEP IRA and a 403(b), 401(k), or even another SEP IRA. Be mindful if you are the owner of multiple businesses sponsoring different plans: You may have to aggregate contributions when determining limits and making contributions to employee accounts.
Are contributions to SEP IRAs automatically invested?
No, you must choose to invest the contributions to your SEP IRA based on the menu of investment options available in your SEP IRA plan.
Can you roll over a SEP IRA?
Yes, you can roll over funds from a SEP IRA into other qualifying IRAs, such as traditional IRAs. You can also convert SEP IRA funds into a Roth IRA, although this may require paying taxes on the money you convert.
It's important to consult a tax professional before completing any SEP IRA Roth rollovers or conversions to avoid unexpected tax burdens. Rolling over or performing a Roth conversion may require you to transfer your SEP IRA funds into a new brokerage.
Can you deduct SEP IRA contributions from your taxes?
Contributions to a SEP IRA up to the annual limit are tax-deductible for the employer and are not subject to federal income tax for the employee, until such time as distributions are made from the IRA. Self-employed individuals can typically deduct the entirety of their allowable SEP IRA contributions.
How are SEP IRA withdrawals taxed?
Those making SEP IRA withdrawals after age 59½ may incur applicable income taxes on what they take out. Remember: The money held in a SEP IRA is like that held in a traditional IRA and has not yet been subject to taxation.
Withdrawals made before the employee is 59½, however, may be subject to a 10% early withdrawal penalty in addition to any applicable income taxes, barring a few exceptions.
Can you have a Roth SEP IRA?
Historically, a SEP IRA could not be a Roth IRA. However, the recently passed SECURE Act 2.0 has made it possible to make Roth contributions to SEP IRAs.