What Is A SEP IRA And How Does It Work? - 1

What Is A SEP IRA And How Does It Work?


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What is a SEP-IRA?

Most people know about both traditional and Roth IRAs or individual retirement accounts. Both types of accounts are a type of retirement account that you can open through an investment brokerage and manage all on your own. The traditional IRA is a retirement account that is similar to the traditional 401k where all of the contributions are tax-deductible. The Roth IRA is a similar account to the Roth 401k where your contribution count as after-tax contributions and you no longer need to pay ANY taxes on that money in retirement. Both types of IRAs allow your money to grow tax-free until retirement and then you have to pay taxes when using a traditional IRA.

However, did you know there is a specific type of IRA that is designed specifically for self-employed people? A SEP or SIMPLE IRA is similar to a traditional IRA in that the contributions are tax-deductible, the money invested grows tax-free until retirement, and like the traditional IRA, you have to pay taxes on the money you take out when retired.

What are the SEP-IRA contribution limits for 2021?

When it comes to the traditional or Roth IRA, you can only contribute a fairly low maximum amount of $6000 per year or $7000 if you are 50 and older for the year 2021. Moreover, this limit is a “shared limit” between both types of accounts. That means if you contribute $3000 into a traditional IRA you can only contribute $3000 in a Roth IRA in the same year.

Luckily, SEP IRAs have much, much higher contribution limits than the traditional or Roth versions. The annual contribution limit of a SEP IRA is $58,000 for the year 2021 and it is also not a shared limit. That means you can contribute the full limit for your traditional and/or Roth accounts and still contribute the maximum limit in a SEP IRA However, there are also some additional rules that mean you might not be allowed to contribute the “maximum” amount.

Some of the extra rules that limit what you are allowed to contribute for the year are:

  • 25% of your total compensation – That means if you make $100,000 in a year, you are only allowed to contribute up to $25,000 for the year as opposed to actual $58,000 limit.
  • There are also no catch-up contributions at 50 years of age like there are with the traditional/Roth IRAs.

what is a sep-ira?

Can you use both SEP and a Traditional/Roth IRA?


Technically speaking you are legally allowed to use a combination of any of these IRAs. Since the SEP IRA has a much higher contribution limit and the limit is not shared between the other types of accounts, this makes using SEP IRAs very beneficial to your retirement portfolio.

However, if you use a traditional and SEP IRA, that might mean that the amount of contributions that you can deduct from an IRA is lower or not available at all. You can read about the traditional IRA deduction limits and rules here. If you use a Roth IRA then you don’t face this issue because the money that you contribute is considered after-tax anyway.

How to open a SEP IRA?

There are many different brokerages in the world that offer SEP IRAs like TD Ameritrade, Charles Schwab, and others. They are also offered by my personal favorite investment brokerage, which is M1 Finance. I like M1 Finance because it allows investing in the WHOLE STOCK MARKET FOR FREE AND WITH FRACTIONAL SHARES!

In order to open a SEP IRA inside an investment brokerage you have to do this first :

  • Create a formal written agreement using the IRS Form 5305-SEP or through your account provider.


Click on the link here to open a SEP IRA with M1 Finance! https://m1finance.8bxp97.net/4edv5o

Note: This page contains affiliate links that will, at no cost to you, earn me a commission. You are in no way obligated to click on the links!

Disclaimer: I am not any sort of investment or financial professional giving any sort of legal advice. I’m just some guy trying to teach other people about how they might navigate the financial world.

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