Ask a CFP®: 'What’s a SEP IRA?'

Ask a CFP®: 'What’s a SEP IRA?'

In our “Ask a CFP®” Q&A series, we cede the floor to a CFP® who will address what we think are some of the trickiest money topics out there.

Today, Natalie Taylor, CFP®, a financial planner with LearnVest Planning Services, discusses what a Simplified Employee Pension IRA (SEP IRA) is and when it makes sense to establish one.


Retirement can conjure up visions of pursuing a passion, hanging with the grandkids or taking epic vacations.

But the ability to do just as you please requires financial freedom—in other words, a sizable nest egg.

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Clients regularly ask me about potential savings vehicles such as 401(k)s and IRAs—but people also hear about other retirement accounts and wonder whether they’re missing out on potential financial benefits.

That’s why I sometimes get asked: What's a SEP IRA?

Why So Many People Ask This Question The SEP IRA isn’t a well-known option. And that’s largely because it usually makes sense only for a subset of retirement savers, namely, small business owners and self-employed people with non-W-2 income.

For the right candidates, though, there’s a powerful case to make for SEP IRAs, as long as you understand the fine print.

What I Tell Them The advantages of the SEP IRA are strong. For starters, it lets you set aside up to 25% of your income (up to $53,000) annually. Traditional IRAs, in comparison, limit you to $5,500 to $6,500, and 401(k)s cap at $18,000 to $24,000.

The contributions come out of your pretax income, and you don’t pay income taxes on the money until you begin to withdraw it after age 59½.

Another giant plus, particularly if you’re prone to upward and downward income swings, is that there are no required annual contributions. That means if you’re having a bad year, you can choose to set aside $0 in the SEP—and then pick it back up once the cash starts flowing in steadily again.

Administrative costs for SEP IRAs tend to be much lower than those of traditional employee retirement plans. If you own a business, you’d likely have your CPA handle filling out the necessary 5305-SEP IRS form and other paperwork; no third-party administrator is needed.

But the drawbacks of SEP IRAs can be equally striking. First and foremost, if you’re an employer, contributions for workers come out of your own pocket—not theirs. Employees can’t contribute their money to SEP IRAs, so it’s essentially your gift.

For small business owners, the SEP has one contribution rule that’s particularly rigid: You have to contribute the same percentage for each employee—you can’t kick in 10% for an employee while rewarding yourself with 25%.

The Bottom Line A SEP IRA tends to cater to individuals who are self-employed or run a small business and is most ideal for someone who has no employees or very few employees. It is also an especially attractive retirement savings option for high earners who have cash left over after paying their bills and can put aside a significant amount of pretax income.

RELATED: Ask a CFP: ‘Is Anyone Ever “Done” Saving for Retirement?’

LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Unless specifically identified as such, the individuals interviewed or otherwise listed in this piece are neither clients, employees nor affiliates of LearnVest Planning Services and the views expressed are their own. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies. LearnVest, Inc., is wholly owned by NM Planning, LLC, a subsidiary of The Northwestern Mutual Life Insurance Company.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

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