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Are SEP IRA contributions tax deductible?

Business owners, freelancers and self-employed should know about the SEP IRA. Is it deductible for employers and employees, and who is eligible?



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Owning and running your own business or even freelancing gives you the independence and freedom of doing what you want, on your terms. It is indeed a powerful feeling. But, where there is such freedom, there is a catch: What about saving for retirement? Who will do that for you?

For business owners, freelancers and self-employed individuals, a Simplified Employee Pension or SEP IRA is a great way to save for retirement, help employees build a nest egg and take some tax credit in the process. Let’s take a closer look at the tax advantages offered by these plans.

Are SEP IRA contributions tax deductible for employers and employees?

Contributions made to an employee’s SEP IRA are tax deductible only for employers, who can claim a certain limit on business tax returns. Contributions made by a sole proprietor may be claimed on personal tax returns.

Contributions are not taxable for employees, and earnings in the form of interest or gains from investments are tax-deferred. Income tax is also applied on withdrawals made from the account, as well as a 10 percent early withdrawal fee on distributions taken before the age of 59.5 years.

What are the eligibility criteria for a SEP IRA?

All eligible employees must be included in an employer’s SEP IRA, and the eligibility criteria are the same for everyone, including owners. To participate, employees must be at least 21 years old. They should have worked for the business for three of the last five yers, and received a compensation of $600 or above from the business during the plan year.


Employees who want to be eligible for a SEP IRA should meet several requirements for qualification. (Source)

Plans may be set up with a lower minimum age or period of employment. Employees who may be excluded from the plan include non-U.S. residents with no U.S. source compensation and those who enjoy retirement benefits as part of their employees’ union agreement.

What are the SEP IRA contribution limits?

  • An employer can contribute up to 25 percent of each eligible employee’s annual compensation or $53,000, whichever is lower. This limit applies to contributions that they make to their own SEP IRA as well.
  • Employees cannot make contributions to an SEP IRA, although they own the funds in the account. Employers choose what percentage is contributed from their pay, or whether to contribute to the plan at all.
  • Owners of a business with no employees may also contribute 25 percent up to a maximum of $53,000 from their net profits. However, they cannot make a contribution if the business shows a net loss at the end of the year.
  • The same SEP IRA contribution limits apply to freelancers and self-employed professionals, but different rules are used to calculate the percentage of earnings that can be claimed as tax deductions.
  • If an employee puts money into another defined contribution plan in the same year, the total amount of both contributions cannot be higher than the SEP IRA contribution limits.
  • Business owners with employees cannot contribute to their own SEP IRA unless they make an equal percentage of contributions for every eligible employee.

SEP IRAs let you make tax deductible IRA contributions for yourself and your employees in a simple and inexpensive manner.

(Featured image by DepositPhotos)

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments. Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday, and NuWireInvestor. If you need help and guidance with traditional or alternative investments, get in touch with Rick.