How to Set Up a SEP IRA and Other Tax Deferred Investment Vehicles

Tax-deferred investment accounts represent one of the most powerful tools for building long-term wealth while reducing your current tax burden. Among these vehicles, the Simplified Employee Pension Individual Retirement Account (SEP IRA) stands out as particularly attractive for self-employed individuals and small business owners. Understanding how to establish and maximize these accounts can significantly impact your financial future.

Read this article to better prepared for retirement.

Understanding the SEP IRA

Says Brandon Stein, of Stein Law, “A SEP IRA functions as a retirement savings plan that allows employers to make contributions toward their own and their employees’ retirement savings.”

 The “simplified” aspect refers to the relatively straightforward setup and maintenance requirements compared to other employer-sponsored plans. For 2024, contribution limits reach up to 25% of compensation or $69,000, whichever is less, making it an exceptionally powerful savings vehicle for high earners.

The SEP IRA proves especially valuable for freelancers, consultants, contractors, and small business owners who want to maximize retirement contributions beyond what traditional IRAs allow. Unlike 401(k) plans, SEP IRAs don’t require annual filing of Form 5500, reducing administrative burden significantly.

Setting Up Your SEP IRA

Establishing a SEP IRA involves three straightforward steps. First, execute a formal written agreement using IRS Form 5305-SEP or a prototype SEP plan document provided by your chosen financial institution. This document establishes the plan’s terms and ensures compliance with IRS regulations.

Second, provide each eligible employee with information about the SEP IRA, including details about contributions and their rights under the plan. The IRS requires that employees receive a copy of Form 5305-SEP or a summary of the plan’s key provisions.

Third, set up individual SEP IRAs for yourself and each eligible employee at a qualified financial institution. Most major brokerages, banks, and investment companies offer SEP IRA accounts with varying fee structures and investment options.

When selecting a provider, consider factors such as investment choices, fees, customer service quality, and online platform capabilities. Popular options include Vanguard, Fidelity, Charles Schwab, and E*TRADE, each offering competitive fee structures and extensive investment selections.

Eligibility and Contribution Rules

Employee eligibility for SEP IRAs follows specific IRS guidelines. Generally, you must include employees who are at least 21 years old, have worked for your business in at least three of the past five years, and received at least $750 in compensation during the current year (as of 2024). Part-time employees meeting these criteria must also be included.

Contribution calculations for self-employed individuals require careful attention to the nuances of self-employment tax. The effective contribution limit for self-employed individuals is typically around 20% of net self-employment earnings after deducting half of the self-employment tax, rather than the full 25% available to employees.

All contributions must be identical as a percentage of compensation for every eligible participant, including yourself. If you contribute 15% of your compensation to your SEP IRA, you must contribute 15% for each eligible employee as well.

Alternative Tax-Deferred Vehicles

Beyond SEP IRAs, several other tax-deferred investment options merit consideration depending on your circumstances.

Solo 401(k) Plans offer even higher contribution limits for self-employed individuals without employees. For 2024, you can contribute up to $69,000 as employer and employee combined, or $76,500 if you’re 50 or older. However, these plans require more administrative complexity and annual filings once account balances exceed $250,000.

Traditional IRAs provide tax-deferred growth with contribution limits of $7,000 for 2024 ($8,000 if 50 or older). While the limits are lower, traditional IRAs offer broader accessibility and don’t require business ownership.

Health Savings Accounts (HSAs) represent a unique triple tax advantage: deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. For 2024, contribution limits are $4,150 for individual coverage and $8,300 for family coverage, with an additional $1,000 catch-up contribution for those 50 and older.

Deferred Compensation Plans allow high-earning employees to defer salary and bonuses to future years, potentially reducing current tax liability while the deferred amounts grow tax-free until withdrawal.

Maximizing Your Strategy

Effective tax-deferred investing requires strategic planning beyond simply opening accounts. Consider your current tax bracket versus expected future tax rates when determining contribution levels. If you anticipate being in a lower tax bracket during retirement, maximizing current deductions through tax-deferred accounts makes sense.

Diversification across account types provides tax flexibility in retirement. Combining tax-deferred accounts with Roth IRAs and taxable investments creates options for managing tax liability when making withdrawals.

Regular review and adjustment of your strategy ensures alignment with changing circumstances. Business growth, income fluctuations, and tax law changes may warrant modifications to your approach.

Implementation Timeline

Begin the setup process well before year-end to maximize current-year contributions. SEP IRAs must be established by your tax filing deadline (including extensions) to count for the previous tax year, but earlier establishment allows for better investment timing and planning.

Tax-deferred investment vehicles offer substantial benefits for building retirement wealth while reducing current tax obligations. The SEP IRA stands out for its simplicity and high contribution limits, making it an excellent choice for self-employed individuals and small business owners. By understanding the setup process, eligibility requirements, and strategic considerations, you can effectively leverage these powerful financial tools to secure your financial future while optimizing your current tax situation.