SEP IRA Investment Option

For far too long, too many Americans have been living with the notion their Social Security benefits would support them in their twilight years. The truth is that’s not likely to happen, especially considering the way the government has mismanaged the SS program. It’s incumbent on all of us to look after our own finances before retiring from the work force.

Fortunately, that same government has given us tax-deferred investment options that should motivate us to invest in our own futures. One of these options is the Individual Retirement Account (IRA). This type of tax-deferred investment option has been offered as an alternative to the 401K investment option that many people can get through their employers.

At this point in time, there are several different IRA options. We are going to discuss the SEP-IRA option.

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Let’s start with a textbook definition for the Simplified Employee Pension – Individual Retirement Account as per the website, “A retirement plan created to benefit self-employed persons and small business owners. Contributions to a SEP IRA are typically 100% tax deductible and earnings grow tax deferred.”

This type of investment option is, for the most part, intended to be used by the self employed, business owners and those folks who don’t have 401K access through their employers because their employers doesn’t qualify to offer a 401K option.

All contributions made under this savings option are tax-deferred. That means the contributions are made with pre-tax earnings. The investment account holder is not required to pay taxes on contributions until such time they begin withdrawing funds. At that time, they will be required to pay taxes based on their own personal statutory tax-rate at the time they make said withdrawals.

At the time the employer makes the election to offer this option, participants must open conventional Individual Accounts for SEP deposits. The investing and tax rules will be the same as conventional accounts in this general category.

While self employed individuals can choose this particular investment option for their future savings, it’s really the small business owner who is going to realize the diverse benefits of this type of investment option. However, there are rules and guidelines that business owners must follow.

The presumption is a business owner will choose this option to provide themselves with a tax-deferred saving option while also being able to offer the same benefit to a very small group of employees. From an employer’s point of view, this is only a viable option if the business is not large enough to qualify for 401K status.

Here’s the reason why this is such an important distinction. If a business owner wants to make a 10% contribution based on their own wages, they must also contribute 10% of each qualified employee’s wages into the employee’s individual account. Obviously, that would be a huge cost if the business owner employed more than a small handful of employees.

As for the term “qualified employees,” here are the guidelines: employee must be at least 21 years of age, had been gainfully employed during three of the last five years, and having made at least $600 in wages in the past year. All employees receive immediate vesting at the time their account is opened. If they have any other type of qualified investment plan, including a Roth, they may combine their savings into their new account. During business downturns, employers may elect to not make any contributions during a fiscal year.

The employer needs to be cautious about where they choose to start the investment option relationship. If they so with a bank, all participants will be restricted to investing in Certificate of Deposit with very safe and small earnings. It’s a far-better option to use a brokerage firm that provides access to stocks and mutual funds.

Unlike traditional accounts, individuals may contribute up to 25% of their earnings, up to a statutory limit as per the IRS. In 2019, that limit is $56,000. From that point own, each participant is permitted to invest at their own discretion as long as the investment options qualify under IRS guidelines.

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