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The SEP IRA  Thumbnail


Powerful tools don’t need to be complicated and they are even more helpful when they provide flexibility. Let’s take a look and see how the SEP IRA offers a small business owner the power to save and potentially deduct a lot of money while alleviating any mandatory contribution requirements.

Does this look like your business?

OwnerStarted 2014 or before$150,000
Employee 1Started 2015$30,000
Employee 2Started 2016$35,000
Employee 3Started 2017$25,000


If it did and you established a SEP-IRA before the 2015 business tax return filing date, including extensions, you would be the only participant in the plan for 2015. Assuming this was W-2 income you could save and deduct, provided this is your only business (1) that sponsors a retirement plan, $37,500. You would need to have this amount of cash available in the business in addition to what you were paid. If the $150,000 was your total income available and you wanted to maximize your SEP contribution then you could contribute approximately $30,000 with earnings adjusted for Social Security and Medicare taxes. The latter also approximates the way non-incorporated businesses operate.

How can you be the only participant when there are 3 other workers? Simply put the law only requires a business to cover individuals who are age 21 and older who have earned at least $550 in 3 of the preceding 5 years. Since all employees started in 2015 or later, the owner becomes the only participant. (Employee 1 would enter the plan in 2018.) A business may choose to adopt provisions that bring employees into the SEP sooner rather than later. (See note below where we describe establishment procedures.)

In this example, the owner chose to contribute the maximum 25% of taxable compensation. There is also a dollar limit per participant of $53,000 in 2016 and $54,000 in 2017. To achieve this level of contribution, greater taxable earnings would be needed.

The owner in this hypothetical company could have contributed less, including not contributing at all. Remember we mentioned flexibility. When and if employees become eligible, flexibility also allows the owner to contribute a lesser percentage of pay or perhaps step-up to a plan (not a SEP) whose allocation formula can be more skewed toward owners and other key employees.(2)

To establish a SEP-IRA the business owner needs to complete a form available on IRS.gov called “5305-SEP”. If the owner has short service himself/herself it is imperative that the checked boxes do not also exclude the owner. (See 3 out of 5-year eligibility rule above.)

Each eligible employee establishes his/her own SEP IRA account and the owner makes the contribution, if any, accordingly. Once an employee is eligible for the SEP IRA, even if the employee leaves before the end of the year for which the contribution is being made, and the owner chooses to contribute each employee must receive his/her appropriate share. These funds belong to the employee and could, theoretically be immediately withdrawn.

Total Wealth Advisors is fully staffed to assist you and your business to establish a SEP-IRA or any other appropriate retirement plan. Please contact us at 612-294-9208 to get started.

This article is for informational purposes only and should not be considered tax or legal advice. Please consult your tax advisor before establishing a retirement program.

  • Individuals that own multiple businesses either singularly or in conjunction with others may need to account for the employees of each entity to determine whether or not the employees are eligible to participate in a plan or if an employee’s (owner’s) contribution is limited.
  • Plans designed to discriminate in favor of owners and other key employees generally require administration by a pension professional including an annual Department of Labor filing. These plans also require the payment of annual fees and must be formally adopted before the end of the employer’s fiscal year. Please discuss a SEP IRA and other qualified retirement plan with your tax professional.