A survey about the operations of a SEP IRA for single owner LLC Schedule C files.

2022 Contribution Limit = $61,000
2023 Contribution Limit = $66,000
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A Simplified Employee Pension Individual retirement account (SEP IRA) is widely regarded as one of the most popular retirement savings plans in the United States. How does it work? Any employer (including self-employed people) can set up this type of IRA and contribute to it on behalf of employees. For most businesses, the maximum contribution to a SEP IRA is 25% of compensation, or $57,000 for 2020 and 2021, whichever is less.

One of the primary benefits of a SEP IRA is the power of deferral. By deferring a portion of their income, employees can reduce their current tax liability and save more towards retirement. In this article, we’ll dive into the power of SEP IRA deferrals and how they work.

Firstly, let’s understand what deferrals mean in the context of SEP IRAs. Deferrals refer to the option for the employee to elect to set aside a certain percentage of their salary or income into their SEP IRA each year. Contributions made to a SEP IRA are pre-tax; that means that the money being invested in the IRA is not subject to income tax. By contributing to a retirement plan such as an SEP IRA, an employee effectively lowers their taxable income for the current year.

For example, if Jane earns $80,000 annually and decides to contribute $20,000 to her SEP IRA, her taxable income reduces to $60,000, thereby moving her into a lower tax bracket. As a result, she could pay less tax on her income, which means that more of her income is being put into her retirement account. The power of deferral is that it’s a win-win for both the employer and the employee.

It’s worth noting that while these contributions are tax-free, they’re not entirely tax-free. Withdrawals made from your SEP IRA after retirement are subject to income taxes at the prevailing rate, just as with traditional IRAs. However, you may be in a lower tax bracket when you retire than you were when you contributed, which means that you may end up paying fewer taxes overall.

Another benefit of SEP IRA deferrals is that they’re entirely discretionary. This means that employees can choose the amount they want to defer each year. Equally, the employer can choose whether to contribute to employee accounts or not. If your employer chooses not to contribute in one year, you can still make contributions as an employee.

In conclusion, SEP IRA deferrals offer a compelling way for employees to reduce their taxable income today, while also saving more towards retirement. They benefit both the employer and the employee by offering tax-deferred savings, which can grow over time. If you’re an employer looking for a retirement plan, or an employee searching for an effective savings plan, the power of SEP IRA deferrals might be the right choice for you.