Planning for retirement is no easy task. However, individuals have a window of opportunity to accumulate savings that will cover their cost of living and other expenses in retirement. Retirement accounts like the SEP IRA alleviate stress and help families build their nest eggs. In this article, we will explore how this individual retirement account works and key information you should know.
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What Is a SEP IRA?
Most full-time jobs offer retirement plans. These plans may help employees reduce their tax bills and build their portfolios. These retirement plans benefit workers, but what about small business owners and self-employed individuals? They may not have a company providing a retirement package for them.
SEP IRAs come to the rescue for small business owners and self-employed individuals. Every contribution is pre-tax in nature. While you will owe taxes when you take a distribution from this account, most people withdraw from their accounts at and during retirement. As a result, you may make less income during this time and fall under a lower tax bracket when you retire.
What are the Pros and Cons of a SEP IRA?
Wondering if a SEP IRA is right for you? We’ve highlighted below the pros and cons of SEP IRAs so you can determine if they make sense for you and how these retirement accounts can complement your financial goals.
Pros:
- Lower tax bill: SEP IRA contributions get special tax treatment. Your taxable income decreases, and you will end up with a lower tax bill. You can keep more of your money now, and take distributions when you retire, so you pay less in taxes.
- Grow your portfolio quicker: Investing is vital for a quick and smooth retirement. You can buy assets that generate cash flow or appreciate while you continue working. Many people understand the benefits of investing but don’t have enough money to invest consistently. A SEP IRA is one of the easiest ways to get started, and both grow your portfolio and trim your tax bill.
- Higher contribution limit: Every individual retirement account has a contribution limit. These limits can change each year, but a SEP IRA comfortably surpasses the competition. While traditional IRA holders can contribute up to $6,500 in 2023, SEP IRA owners have a $66,000 limit, depending on compensation, for 2023. The SEP IRA’s max is 10 times higher than a traditional IRA.
Cons:
- Fees: Retirement accounts aren’t free, and fees can eat into your profits before taxes come into play. You can’t do much about an employer’s retirement plan, but small business owners and self-employed individuals can shop around when looking for SEP IRAs.
- No catch-up contribution program for SEP IRAs: Traditional IRAs have catch-up programs that increase your maximum contribution after you turn 50. SEP IRAs do not have this advantage, but their $66,000 maximum contribution limit for 2023 makes up for it.
- Not everyone gets the maximum contribution limit: SEP IRA contributions are capped at $66,000 in 2023, or 25% of your compensation, depending on which is lower. If you make $150,000 with your business, you cannot contribute $66,000 to your retirement account, but the contribution amount allowed will still exceed the maximum for a traditional IRA.
- You cannot distribute until turning 59 ½ years old to avoid tax penalties: You have to pay taxes in either case, but if you distribute funds before turning 59 ½ years old, you will owe an additional 10% penalty tax for the early distribution. Some distributions are exempt from this rule, depending on how you use the cash.
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Titan is an investment platform with a team of experts actively managing your portfolio based on your chosen strategy, including cryptocurrencies.
Alto IRA allows you to invest in stocks, bonds, mutual funds, ETFs, real estate, cryptocurrencies, and even gold for your retirement.
Important SEP IRA Rules You Should Know
Are you ready to get started with a SEP IRA, or do you still find yourself on the fence? Keep these rules in mind before deciding if this retirement account is right for you.
Eligibility Rules
The SEP IRA isn’t for everyone. You have to fulfill these criteria to qualify for a SEP IRA plan.
- Be at least 21 years old
- Worked for the employer in at least three of the last five years
- Earn at least $750 in compensation this year
Employees in unions or who do not receive compensation from their employers can find themselves blocked from this choice. The employer can make this choice but cannot create additional hurdles for employees seeking SEP IRA plans. Business owners and self-employed individuals have a clearer path to SEP IRAs.
Contribution Limits
SEP IRA investors benefit from generous contribution limits relative to traditional IRA holders. For example, SEP IRA holders can contribute $66,000 in 2023, or 25% of their compensation, depending on which is lower. The IRS may raise the maximum IRA contribution limits each year.
Distributions
SEP IRAs defer your tax payments, but you will still owe taxes on distributions. SEP IRAs do not have a component for people who prefer Roth IRAs, so paying taxes on distributions is not optional. You must begin withdrawing from your account when you turn 73. IRA holders may avoid the 10% early withdrawal penalty if they start withdrawing at 59 ½ years old or for qualifying expenses.
Rollovers
You can roll your SEP IRA into a traditional IRA or Roth IRA. Nothing changes if you go the traditional route. Funds remain tax-deferred, and you only pay when you make withdrawals. Rolling over to a Roth IRA results in an income tax on the amount you roll over. This event can put you in a higher tax bracket and increase this year’s tax bill, but you won’t have to worry about taxes on future capital gains and dividends in your Roth IRA.
Setting Up Your Account
You can set up an account with an employer you work for or through an IRA provider if you are a business owner or a self-employed individual. You will have to provide basic information to set up an account and must fulfill the requirements for a SEP IRA.
Investing
You can buy stocks, mutual funds, and other assets with a SEP IRA. A self-directed SEP IRA gives you more flexibility in which assets you can buy.
Account Maintenance
A SEP IRA is easy to maintain once you get started. You can work with a custodian who does the legwork after you set up your account.
Invest in Your Retirement Today with a SEP IRA
A SEP IRA is a supersized IRA plan with a higher contribution limit. Investors can put up to $66,000 into their retirement accounts in 2023, which is more than 10 times the limit for traditional IRAs. Many aspiring retirees put stocks and mutual funds in their retirement accounts, but that’s often because they have few other choices. A self-directed SEP IRA expands your possibilities.
