Saving for retirement isn't easy, especially in today's economy.
Tight margins, high debt loads, and other factors conspire against W-2 wage earners and entrepreneurs, causing them to contemplate putting off retirement savings for "one more year". At the same time, it's becoming apparent that a consistent retirement savings plan is essential for workers who hope to someday retire in relative comfortable circumstances.
Many business owners and workers use the complexity of retirement benefit mechanisms as an excuse to delay saving for retirement. Some types of retirement plans have high startup costs and strict requirements, making them even less appealing for business owners who lack the resources to guarantee consistent, long-term contributions. SEP IRAs eliminate a lot of the arguments against retirement savings. They are cost-effective and highly flexible – a perfect fit for small businesses.
Another significant benefit for SEP IRAs is that they have extremely high contribution limits. This makes it easier for small business owners and employees to compensate for inadequate contributions in previous years so they can keep pace with their retirement planning schedule. If the business has a bad year, contributions can be reduced and compensated for next year, when the bottom line is a little healthier.
SEP IRA Contribution Limits
Contribution limits for SEP IRAs are high compared to other IRAs. Employers are permitted to contribute the lesser of $49,000 or 25% of the individual's compensation into a SEP each year. Other IRA plans have significantly lower contribution limits and require the employer to make contributions each year. Since SEPs don't require any annual contributions, they would seem to represent the best of both worlds. So what's the catch?
The catch is that if employers choose to make a SEP contribution in a given year, they have to contributions for all of their employees who are eligible to receive a SEP contribution, i.e. all employees who are over 21 years of age and have served the business for three of the last five years. So if the business owner decides to make a 10% contribution to his own account, he also has to make a 10% contribution to his employees' accounts.
Other types of IRAs offset the business owner's financial commitment by allowing for salary deduction employee contributions. Regardless of whether or not the employer contributes to the account, employees can contribute to their personal accounts through paycheck deductions. But with a SEP, salary deduction employee contributions are prohibited. Employers are completely responsible for the financial burden of the IRA.