Does a SEP IRA Reduce Taxable Income?
Explore how a SEP IRA can effectively lower your taxable income while planning for retirement, including key rules and deadlines.
A SEP IRA, or Simplified Employee Pension Individual Retirement Account, offers substantial tax advantages for self-employed individuals and small business owners. By allowing contributions to be deducted from taxable income, it helps reduce tax liabilities while building retirement savings.
Eligibility Requirements
To establish a SEP IRA, employers, including self-employed individuals, must qualify. Any business owner—whether operating as a sole proprietor, partnership, corporation, or nonprofit—can set up a SEP IRA. The IRS does not impose limits on the number of employees a business can have, making it accessible to various business types.
Employees must meet certain criteria: they must be at least 21 years old, have worked for the employer in at least three of the last five years, and have earned at least $750 in compensation during the current year. Employers may adopt less restrictive criteria but cannot impose stricter requirements.
Contribution Limits
Contribution limits for a SEP IRA are set by the IRS and are crucial to maximizing its benefits. For the 2024 tax year, the limit is the lesser of 25% of an employee’s compensation or $66,000. Contributions are made solely by the employer and must be equal in percentage for all eligible employees. For example, if an employer contributes 10% of their own compensation, they must contribute 10% of each eligible employee’s compensation.
Self-employed individuals calculate contributions differently, based on net earnings from self-employment, adjusted for the self-employment tax deduction. For instance, with $100,000 in net earnings, their contribution would be approximately $18,587 after adjustments.
Reporting and Deduction on Tax Returns
SEP IRA contributions must be accurately reported on tax returns. Sole proprietors, partnerships, and LLCs typically report contributions on Schedule C and Form 1040. Corporations use their respective corporate tax forms, such as Form 1120 for C corporations or 1120-S for S corporations.
Contributions for a given tax year must be made by the tax filing deadline, including extensions. For the 2024 tax year, this means contributions can be made until April 15, 2025, or October 15, 2025, if an extension is filed. This timeline allows businesses to evaluate their financial standing before finalizing contributions.
Coordination with Other Retirement Accounts
A SEP IRA can operate alongside other retirement accounts, such as Traditional IRAs or Roth IRAs. Contributions to a SEP IRA do not affect the limits for these personal IRAs, enabling individuals to maximize savings across multiple accounts. For 2024, individuals can contribute up to $6,500 to a Traditional or Roth IRA in addition to SEP IRA contributions.
Businesses offering other plans, like a 401(k), must ensure compliance with IRS limits. Combined contributions to a SEP IRA and a 401(k) cannot exceed the overall defined contribution plan limit, set at $66,000 or 100% of the participant’s compensation for 2024.
Key Deadlines
Deadlines are critical for SEP IRA contributions. The contribution deadline coincides with the employer’s tax filing deadline, including extensions. For example, sole proprietors filing taxes for 2024 by April 15, 2025, must contribute by that date, or by October 15, 2025, if an extension is filed.
A SEP IRA must also be established by the tax filing deadline, including extensions. Unlike some other retirement plans, there is no requirement to open the account by the end of the calendar year, giving businesses flexibility to both set up and fund the account early in the following year. Missing these deadlines, however, results in lost opportunities to benefit from the plan.