When Agents (or other self-employed individuals) consider their options for retirement savings, the SEP IRA should be at the top of their list. The SEP IRA provides an easy way for self-employed business owners (like Real Estate Agents) to maximize their retirement savings. In an industry that generally doesn’t offer formal retirement plans, Agents need a 401k alternative.
Not all IRAs are created equal. Here are the top 5 reasons why Real Estate Agents should consider the SEP IRA their best option for retirement savings.
Please note: The following information is intended to present IRS rules as they would apply to most self-employed individuals, creating a SEP IRA for their own benefit, using their own business (S-Corp) entity. Tax situations may vary, so always consult with your CPA if you have questions. Contribution and income limits and rules are subject to change. Additional rules and considerations apply if your business has employees, so please seek legal and tax advice in this case.
1. The SEP IRA was created especially for business owners
SEP stands for Simplified Employee Pension. In the Real Estate industry, we’re lacking the cushy 401(k) plans of the corporate world, so it’s up to us to find an alternative retirement savings account. The SEP IRA is created to help.
According to the IRS, “A SEP plan provides business owners with a simplified method to contribute toward their employees’ retirement as well as their own retirement savings.”
SEP IRA accounts are treated much like a traditional IRAs, in terms of overall rules for rollovers, distributions, etc. However, they are specially designed to make it easier for business owners to make contributions toward their own retirement. And who doesn’t love it when the IRS simplifies things? Right?
SEP IRA Basics:
– A SEP IRA can be established by any employer or self-employed individual
– Contributions to a SEP IRA are always made by the employer
– Contributions for a given year must be made by the tax filing deadline (including extensions)
– SEP IRAs are only available to individuals over age 21
– An individual must have worked for the contributing employer for at least 3 of the most recent 5 years
– Like other IRAs, funds are subject to a 10% penalty if accessed before age 59 1/2(IRS, 2022)
2. Annual contribution limits are higher
When it comes to fast-tracking your retirement savings, the SEP offers a lot of bang for the buck. As of 2022, the maximum amount an individual is allowed to contribute to a Traditional or Roth IRA in a single year is $6,000. By comparison, the SEP IRA contribution limits for 2022 are as high as $61,000 for an individual (depending on income level).
That means and individual could contribute $55,000 more dollars to your SEP every year vs. a Traditional or Roth IRA.*
Let that sink in. It’s a HUGE difference. And the IRS adjusts the limits for cost of living, so the amounts are generally increased each year!
* Keep in mind that you may not be eligible to contribute the full $61,000, because each individual’s maximum contribution is calculated based on that year’s income. The official IRS rule states that contributions each year cannot exceed the lesser of: 1. 25% of compensation, or 2. $61,000 for 2022. For what it’s worth, the cap for 2021 was $58,000 and the cap for 2020 was $57,000.
Even if you don’t qualify for the maximum contribution, suppose your compensation for the 2022 tax year was $60,000. Your business (as employer) would be allowed to contribute $15,000 ($60,000 * 0.25) to your SEP IRA for the year. That’s still more than double the measly $6,000 cap of a Traditional or Roth IRA!
Are you ready for more good news? You can combine forces, and maintain a SEP IRA alongside a Traditional IRA (or Roth IRA, assuming you qualify) in the same year! So if you’re looking to build retirement savings at warp-speed (well, at least a speed that’s allowed within the confines of IRS rules), the SEP IRA can be an essential tool.
3. The money you contribute to a SEP IRA reduces the overall taxes due for your business
In case you’re not already convinced that the SEP is the best IRA option for Real Estate Agents, there’s more. It’s worth noting that SEP contributions are not subject to federal income tax withholding. That means the contributions your business makes to your SEP IRA are tax-deductible.
Put another way, this means you can take a dollar-for-dollar line item deduction on your business return. The deduction amount will be equal to the amount your business contributed to your SEP for the year.
That can amount to some pretty big reductions in tax for your business, especially if you are in your peak earning years.
Finding ways to reduce our taxes is cause for a happy dance.
SEP tip: Avoid an easy mistake, and make sure you are contributing to your SEP as the employer, not directly from a personal account.
4. The contribution rules are flexible
Real Estate Agents and other self-employed individuals might know better than anyone how much cash flow can impact a business. Receiving income in large chunks (the way we receive commissions) means that your income may vary significantly year-over-year.
To that end, it brings peace of mind to know that there are no minimum contributions amounts for a SEP IRA account. In years when funds are tight, you are allowed to scale back contributions. Actually, there is no requirement to contribute at all.
So while it’s not ideal to stop funding your retirement savings accounts, (especially if you are hoping to retire early), the SEP offers great flexibility for business owners. If your business hits an unexpectedly slow year, you’re under no obligation to make a SEP IRA contribution.
5. SEP IRAs are widely available and easy to open (and terminate)
SEP IRAs are easily established, and there are no IRS reporting rules for the employers that fund them. On the flip side, you can also easily terminate your SEP, if needed.
You may need IRS Form 5305-SEP when you set up your account, but the retirement plan provider you choose can generally help with the required plan documents. Consult a tax advisor to be sure you meet the requirements.
According to the IRS, “SEP contributions and earnings may be rolled over tax-free to other IRAs and retirement plans.”
This makes for an easy-in, as well as an easy-out. You can make the most of contributions during your earning years, and later roll assets and earnings into another IRA should you need to consolidate accounts.
Hopefully now, you have a better understanding of the many reasons why the SEP IRA is an excellent 401k alternative, and may be the best retirement account option for Real Estate Agents.
Thinking through the types of investments you plan to hold in your SEP IRA is a good exercise before deciding where to establish your account.
If you’re an index fund investor like me, you’ll likely hold a large portion of your retirement savings in just a handful of individual investments. It’s worthwhile to ensure ahead of time that your ideal investments will be available to you. You’ll also want to confirm that you can purchase without the account provider tacking on any unnecessary fees.
Over the long haul, even small fees add up and will hamper your savings efforts. Do your research.
Finally, there is One SEP IRA limitation to be aware of. Participant Loans are NOT permitted.
This may not matter for most of us… but if you’re a savvy investment property investor, and need access to retirement funds as collateral, the SEP will not be the retirement savings account for you.