SEP (Simplified Employee Pension) plans are a type of retirement plan, similar to a 401(k), for small businesses and self-employed individuals.
SEP IRAs are cheaper and simpler to set up and manage than 401(k)s. As a result, they are an attractive option for single-employee owner-run businesses. Their main downside is that they provide fewer features than 401(k) plans. Most notably, SEP IRAs don’t allow a Roth option.
SEP IRAs are a tax-deferred savings vehicle, meaning that contributions to the plan are deducted on your taxes now and only taxed when you withdraw the assets. Like other tax-deferred savings, SEP IRAs are subject to Required Minimum Distributions in the year you turn 70 1/2 years old.
You can have and participate in both a SEP IRA and 401(k) plan. The IRS very clearly says, “Yes, you can set up a SEP for your self-employed business even if you participate in your employer’s retirement plan at a second job.”
But if you have both a SEP IRA and a 401(k) plan, can you still contribute to both? The short answer is yes.
There are two different contribution limits at play when it comes to employer-sponsored retirement plans.
The first is the employee contribution limit. This is the one most people know and reflects how much salary an employee is allowed to defer into the plan. This is called the “basic elective deferral limit” by the IRS. Currently in 2016, the limit is $18,000.
This employee contribution limit is the amount you can defer to all of your plans, meaning the employee contribution limit is per person not per plan.
This contribution limit applies to 401(k), 403(b), and SIMPLE plans. SEP IRAs actually do not permit elective salary deferrals.
The second contribution limit is the overall contribution limit and is the amount of total annual contributions allowed to “all of your accounts in plans maintained by one employer.” Since this limit is higher, the employer is the only one who can cause an employee’s contributions to reach their overall limit. As a result, it is easiest to think of this as the employer contribution limit. Since your employer would have no way of knowing what other employers of yours are doing, this is a per-plan limit.
For SEP IRAs though, there is one more string attached. You can contribute up to $53,000, but your contribution is limited to 25% of your total compensation from the job with the SEP plan. This means that you would have to make $212,000 to legally contribute the maximum to your SEP IRA. You can read more about that in our article “How Much Can I Contribute To My SEP IRA?”
This overall contribution limit includes employee elective deferrals. That means that if the employee takes advantage of their $18,000 contribution, then the remaining amount of the maximum contribution limit for the employer to use is only $35,000. This affects 401(k) plans, where employee deferrals are allowed, but does not affect SEP IRAs, where no such deferrals are permitted.
Assuming that you are the owner of a business with a SEP IRA and an employee of a different, unrelated business that has a 401(k) plan, this means that the maximum you can contribute to your retirement plans is $71,000. That comes from:
- an $18,000 employee salary deferral to your 401(k), ideally to your Roth 401(k)
- a $53,000 employer contribution to your SEP IRA, assuming you make over $212,000 from your SEP IRA business
Your 401(k) plan employer may also contribute another $35,000 to your 401(k) plan, to bring the total up to $106,000 of employer-sponsored retirement plan savings, but it’s your employer’s decision, not yours.
Like all employer plans, you can contribute to your employer plan(s) and also contribute to an IRA, like your Roth IRA. This means that you can save an additional $5,500 in your Roth IRA, for a grand total of $111,500 of retirement savings.
This is good news for people trying to get a new business launched but can’t yet give up their main job.
With high contribution limits, SEP IRAs offer a powerful way to provide for your own retirement in the same way that 401(k) plans do. Don’t let confusion about your past savings keep you from saving for your future now.
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