Different employers offer different ways for their workers to save for retirement, and SEP IRAs are one popular way that smaller businesses and self-employed individuals can set up a retirement plan. For 2017, the contribution limits for SEP IRAs are set to go up, giving those who make maximum use of SEP IRAs even more flexibility to boost their retirement savings. Below, we'll show you the changes to the 2017 SEP IRA limits, as well as going into more detail about what these plans let you do.
Changes to the 2017 SEP IRA limits
One of the most attractive things about SEP IRAs is that they have extremely high contribution limits. Employers can contribute up to a quarter of the salaries that each employee earns up to an annual maximum limit. For 2017, that maximum will be $54,000, up $1,000 from its 2016 level. That's the first rise in the SEP IRA limit since 2015, because inflation levels were so low last year that they didn't produce any increase in the figure for the 2016 tax year.
Note that the 25% limitation works a little differently for those who are self-employed. In that case, the 25% refers to the self-employed worker's net earnings from the business. To calculate that figure, you have to start by taking out the half of the self-employment tax, which represents the employer's portion of the payroll taxes that go toward Social Security and Medicare. Next, you have to account for the fact that the contribution to the SEP IRA reduces the taxable earnings from the business. The net result of that math is that the 25% limitation on net earnings works out to 20% of your adjusted profit after the self-employment tax adjustment.
Why SEP IRAs are useful
SEP IRA stands for Simplified Employee Pension Individual Retirement Arrangement, and the ease of use that SEP IRAs offer is a big reason why businesses consider them. They're easy to set up and maintain, lacking many of the intricacies that other types of employer retirement plans require. For instance, 401(k) plans require adoption agreements and have complicated reporting requirements that can make them a nightmare for small businesses to handle. By contrast, a single IRS form is all you typically need to set up a SEP IRA, and most financial institutions will open accounts with minimal additional paperwork. Investment options are also usually much broader than with 401(k) plans, offering just about any type of investment that you could make in a regular IRA and including the vast majority of assets that most investors would choose.
One thing to keep in mind, though, is that SEP IRAs are entirely up to the employer to establish and fund. The accounts don't allow employees to contribute from their own pay, and only business owners and self-employed workers who play the role of both employer and employee can use SEP IRAs to their maximum extent for planning purposes.
At the same time, the price of using SEP IRAs for small business owners is that you can't just contribute to your own SEP IRA account if you have employees. Instead, you have to be consistent in the percentage contributions you make across all eligible employees. You can impose some limited restrictions on who's eligible, including a three-year work requirement. However, once an employee is part of the plan, equitable treatment is required.
SEP IRAs aren't the only retirement savings vehicle available to individual self-employed workers and to small businesses. However, their ease of use and their high contribution limits make them a valuable tool for successful entrepreneurs, and the $1,000 increase in the 2017 SEP limits to $54,000 will add even further incremental gains to the picture.