The Pros and Cons of a SEP Account in Today's Volatile Markets

Today’s seesaw markets can be worrisome to investors saving for retirement. Watching account values rise and fall can cause you to feel anxious about your simplified employee pension (SEP) plan. A SEP retirement account’s advantages vary depending on the setup. However, your SEP has more advantages than disadvantages, even during times of market volatility. The major con for investors is not choosing to participate in a SEP when one is offered. This article examines the benefits and drawbacks of SEP accounts in more detail.

Key Takeaways

  • A simplified employee pension is a type of individual retirement account that an employer or a self-employed person can establish.
  • A SEP IRA is designed to help a company's employees save for their retirement.
  • A SEP can also be set up by the self-employed owner for their own benefit.
  • The maximum total contribution limits are the lesser of 25% of an employee’s compensation or $66,000 in 2023 and $69,000 in 2024.

Saving More

A SEP is a type of individual retirement account (IRA) that an employer or a self-employed individual can establish. A SEP IRA is designed to help a company's employees save for their retirement, or a SEP can be set up by the self-employed owner for their own benefit.

However, the contributions are not funded by the employees, as in the case of a 401(k), but instead, a SEP IRA is funded by the employer. The contributions are made directly to the employee's IRA. A SEP is a good retirement savings vehicle. However, rules limit the amount that can be contributed. The maximum contribution limits in 2022 and 2023 are the lesser of:

  1. 25% of an employee’s compensation (subject to $330,000 in 2023 and $345,000 in 2024), or
  2. $66,000 in 2023 and $69,000 in 2024

Account Set Up

SEP accounts are usually set up by the self-employed or a small business. The maximum value of contributions cannot exceed the lowest of the two values. Thus, both values should be calculated to determine the limit.

If a SEP is established as an IRA, individuals can usually make individual contributions up to the traditional IRA limit of $6,500 in 2023 ($7,000 in 2024) with an additional $1,000 contribution allowed each year for those over the age of 50.

SEP accounts are often a top choice for self-employed sole proprietors because they allow them to make pre-tax contributions to a retirement account of potentially $66,000 in 2023 and $69,000 in 2024 while also taking a business expense deduction. Sole proprietors are subject to special calculations for the deduction. Overall, each SEP plan will have its own provisions depending on the setup and contributor(s).

Employers are required to contribute the same percentage to each employee's account, including their own as an owner. Sole proprietors may decide to choose a solo 401(k) as an alternative to a SEP.

A solo 401(k) is similar to a SEP account, but it has its own rules and regulations. The solo 401(k) can allow for salary-deferred contributions of up to $22,500 in 2023. This amount increases to $23,000 in 2024. However, a solo 401(k) is subject to its own special maximum contribution calculations.

Whether you are an active or passive investor, you will have much larger retirement savings than people who do nothing.

Tax-Free Accumulation

The tax benefits of a SEP are basically the same as those of a 401k or other pre-tax retirement savings vehicle. All earnings accumulate with no immediate income tax obligations. Savings compound at a relatively high rate, giving you more money after retirement even after future taxes are paid on withdrawals.

SEP contributions can also be deductible for the contributor though deductions can vary depending on the situation.

Employee Benefit

Most small businesses offer little in the way of pension benefits. An employer making profit-sharing contributions on behalf of its employees is providing a benefit that helps attract and retain quality employees at a lower cost than increasing salaries.

Changing Investments Without Tax Liabilities

A SEP is a vehicle you can use to manage a portfolio actively. All trades are made with no tax consequences. You can base decisions on total return and what market conditions dictate.

Many SEP providers offer a wide range of investment choices, such as exchange traded funds (ETFs), which contain a basket of stocks to help diversify the risk associated with investing in the equity markets.

Dollar-Cost Averaging

Mutual funds, which are portfolios of securities managed by an investment manager, are common investment vehicles in SEP accounts. Savers can choose from several mutual funds and have their contributions deposited regularly.

This passive investment strategy is a major pro in the downward stage of a volatile market since dollar-cost averaging automatically takes place. Every deposit purchases a greater number of fund shares as the market goes down and fewer shares when it is rising.

What Are Some of the Advantages of a SEP Account?

Some of the advantages of a SEP account include a reduction in taxable income, tax-deferred compounding, high contribution limits, and a practical way to save for retirement.

What Are the Contribution Limits for a SEP Account?

The contribution limit for a SEP account is the lesser of 25% of an employee's income or $66,000 in 2023. This amount rises to $69,000 in 2024.

Can I Contribute to a SEP Account?

As an employee, you cannot contribute to a SEP account. Only employers can contribute to a SEP account and they decide the amount that is contributed. An employer can also decide not to contribute any amount at all.

The Bottom Line

SEP accounts have a great deal of variation for sole proprietors versus employer contributions for employees. Like any employer-offered retirement plan, SEP accounts can increase the pay received beyond a standard salary. In fact, they are usually set up as an additional employee benefit.

Employees can take advantage of all the pros with minimal account management. If market volatility is driving the market down, shift to conservative investments, such as bonds. If the market starts to rise, shift assets back to stocks. If you don't want to be bothered, pick a no-load asset allocation mutual fund targeted to retirement goals and let professional portfolio managers make the market-timing decisions.

For sole proprietors, SEP accounts offer the same advantages as for employees. Sole proprietor SEP accounts can be a great vehicle for individual investment savings with the option for a business expense deduction. Sole proprietor SEP contributions can be subject to their own limitations, so extra research and planning may be required.?

Article Sources
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  1. Internal Revenue Service. "2024 Limitations Adjusted as Provided in Section 415(d), etc.," Page 1.

  2. Internal Revenue Service. "Simplified Employee Pension Plan (SEP)."

  3. Internal Revenue Service. "401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000."

  4. Internal Revenue Service. "SEP Plan FAQs,"

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