SEP Versus Traditional IRAs

What Every Small Business Owner and Entrepreneur Needs to Know

While most people prepare for retirement, in part, by participating in their employer’s 401k/retirement plan, you’re not most people.

As a small business owner, a self-employed individual, or someone who earns freelance income, you don’t have the luxury of leaning on someone else plan. But what you do have at your disposal is a SEP IRA.

Formally called a Simplified Employee Pension, SEP IRAs really are a simplified retirement savings tool.

Like traditional IRAs, they allow you to contribute to your retirement, and, if you have employees, to their retirement as well. But unlike traditional IRAs, SEPs have a few distinct advantages:

• – they’re easier to manage than traditional IRAs and typically don’t impose start-up costs or annual fees
• – contributions are tax-deductible for the business
• – they allow you to set aside more money for your (and/or your employees’) retirement savings than traditional IRAs

This last point is a particularly important differentiator. Here’s why: Unlike Traditional IRAs, which have set contribution limits for individuals, contribution limits for SEP IRAs are based on a percentage of each employee's compensation.

For comparison, the cap for a traditional IRA in 2023 was $6,500 with the option of an additional $1,000 catch-up contribution if you're 50 or older. The cap for SEP IRAs for 2023 was up to 25% of your compensation or $66,000 (FYI, that will jump to $69,000 in 2024). This means you can potentially contribute up to 10x more to your retirement savings through a SEP IRA than you could with a traditional IRA.

If you are an employer, it’s important to note that if you have employees, you can’t just set up a SEP for yourself; you must set one up for each eligible employee. Similarly, if you make a contribution to your own SEP, you must contribute the same percentage of compensation to every eligible employee’s account, too.

However, another nice perk of SEPs is that you can be flexible in what you contribute year to year. Say you have a super profitable year; you can push contributions up to the cap and share the wealth with employees. But if things are running tight, you can skip contributions altogether.

As a reminder, if you already have a SEP, you can still make tax-deductible contributions for 2023 through April 17. Just remember you can’t exceed the cap percentage or amount and, if you’re an employer, you must make the same percentage contribution for all employees.

DISCLAIMER: This article is meant for educational purposes only and is not intended to be construed as financial, tax, investment or legal advice.