The Best Retirement Plans for Small Businesses: Part 2, the Simplified Employee Pension (SEP) Option
This is Part 2 of our guide to the best tax-advantaged retirement plans for small businesses. If you missed Part 1, you can find it here.
In this article, we’ll focus on a straightforward and flexible option: the Simplified Employee Pension (SEP) for small businesses. SEPs are designed to help self-employed individuals and small business owners save for retirement with minimal hassle.
What is a Simplified Employee Pension (SEP) for Small Businesses?
A SEP is a type of defined contribution retirement plan. This means you make annual contributions to your retirement account based on a percentage of your income or salary. These contributions are tax-deductible and subject to an annual cap.
One key advantage of SEPs is flexibility. Contributions are entirely discretionary, so you can adjust the amount based on your business’s financial health each year. Let’s explore why SEPs might be the best fit for your small business.
Why Choose a Simplified Employee Pension (SEP) for Small Businesses?
Perfect for Small Businesses and Self-Employed Individuals
SEPs work particularly well for one-person businesses or husband-and-wife teams with no additional employees. If you’re self-employed, a SEP allows you to make significant contributions to your retirement account without dealing with complex rules.
High Contribution Limits
For 2024, you can contribute up to 25% of your salary or 20% of your self-employment income, with a maximum cap of $69,000 (subject to inflation adjustments).
Easy Setup and Administration
Setting up a SEP is quick and simple. Most financial institutions can guide you through the process. Once established, there are no annual government filings required, making it one of the easiest plans to maintain.
How Simplified Employee Pensions (SEPs) Work for Different Business Types
If You’re Self-Employed
For sole proprietors, LLC members, or partners, the deductible contribution limit is the lesser of:
- 20% of your net self-employment income (after reducing for half of your self-employment tax), or
- The annual cap ($69,000 in 2024).
If You’re Incorporated
For S or C corporations, the business sets up the SEP, and contributions are made on behalf of the employee (you). The deductible contribution limit is the lesser of:
- 25% of your salary, or
- The annual cap.
Key Benefits of a Simplified Employee Pension (SEP) for Small Businesses
Flexible Timing
You can set up and contribute to a SEP as late as the extended due date of your tax return for the prior year. For example, if you extend your tax return to October, you can still establish and fund a SEP for the previous year by that date.
Simple Setup
Opening a SEP is easy. You’ll only need to complete Form 5305-SEP, which takes about five minutes. Many financial institutions also provide streamlined services to help.
Minimal Paperwork
SEPs don’t require annual government filings, unlike other plans. All you need to do is share basic information with any eligible employees each year.
Contribution Flexibility
You’re never obligated to contribute a set amount. In lean years, you can contribute less or skip it altogether. In profitable years, you can contribute up to the maximum limit.
Potential Drawbacks of Simplified Employee Pensions (SEPs)
Employee Coverage Rules
If you have employees, you must contribute the same percentage of their salaries as you do for yourself. Eligible employees include those who:
- Are 21 or older,
- Have worked for your business in at least three of the last five years, and
- Earn more than $750 annually (2024 threshold).
This can make SEPs less appealing for businesses with many employees.
Lower Contribution Limits for Some Alternatives
Other plans, like a solo 401(k) or defined benefit pension plan, may allow higher contributions based on your income. These plans can also offer additional features, such as borrowing options, which SEPs don’t provide.
Immediate Vesting
Contributions to employee accounts are 100% vested immediately. This means employees can take the funds with them if they leave your business.
Is a Simplified Employee Pension (SEP) Right for Your Small Business?
A SEP is an excellent choice if you want a simple, flexible retirement plan. It’s especially appealing if you:
- Don’t have employees or want to include employees in your retirement plan, or
- Need a last-minute way to reduce your taxable income for the prior year.
If you expect to have higher income or a more complex employee situation, you might benefit from exploring other options like a solo 401(k) or a defined benefit plan. Stay tuned for our next article, where we’ll cover these alternatives in detail.
The Bottom Line on Simplified Employee Pensions (SEPs) for Small Businesses
The SEP is a hassle-free, tax-advantaged way to save for retirement. It offers high contribution limits, flexibility, and minimal administration, making it one of the best options for small business owners and self-employed individuals.
If you’re ready to start saving for retirement, contact your financial institution or tax advisor today to learn more about setting up a Simplified Employee Pension (SEP) for your small business.
Still thinking about how to save on your tax before the year ends, here is our post on tax strategies you can employ.
To learn how to earn tax-free income with the Augusta Rule, we have this article with all the information you need.
What is an EIN and how can you apply for it for your business? Read about it here and follow the IRSguidelines and set your business up for success by applying for an EIN today!
