How to Read Your SEP IRA Calculator Results
- Suggested Employer SEP IRA Contribution: Your suggested contribution should be the same as the desired amount that you input unless your desired contribution exceeds 25 percent of income or $55,000. If your income is too low, your desired contribution may be too high. If your suggested contribution is under $6,000, you shouldn’t be using a SEP.
- Employee SEP Contributions (if applicable): Employee contributions are the same as employer contributions—proportional to annual compensation. If your employees are highly paid, your cost of employee contributions may exceed $25,000 per year.
- Five-Year Growth Projection Rule of Thumb: If your contributions are good, your balance after five years should match or exceed the employer income from the inputs tab. If contributions are low, your projected balance won’t match pre-tax employer income.
- Next Steps: If you want to learn more about SEP IRAs, where you can get one, and the investment options available.
If you don’t yet have a SEP IRA and are thinking about establishing a plan, it’s important to understand the contribution limits, rules, and deadlines for SEPs. You can learn more about how SEPs work and how to use them by reading our ultimate guide to SEP IRAs.
How the SEP IRA Calculator Works
The free SEP IRA calculator above can help self-employed individuals and small business owners determine their maximum SEP IRA contribution for the year. For business owners who have employees, the calculator can also provide the required SEP contributions for all employee accounts based on the contribution an employer makes for their own account.
SEP IRA Calculator Inputs
Using the free SEP IRA calculator above requires users to provide a number of inputs. These inputs are based on employer income, employee compensation, and desired employer SEP IRA contributions. These are the factors that determine whether an employer can make their desired SEP contribution and how much employers must contribute to employee accounts.
The three inputs for the SEP IRA calculator above are:
1. Employer Taxable Income
The taxable income of a business owner or self-employed individual is the primary factor in determining your SEP IRA contribution limit and contributions for any employees. SEP contributions are limited to $55,000 or 25 percent of taxable income, so calculating your contribution limit starts with entering your taxable income into the SEP IRA calculator.
2. Desired Employer SEP IRA Contribution
If your desired SEP IRA contribution is under your contribution limit, then the SEP IRA calculator will keep it as your suggested SEP contribution. If, however, your desired contribution is too high, the calculator will use your desired contribution to calculate a suggested contribution amount.
3. Total Employee Compensation
In addition to inputting your own employer data, if you have employees, you can also provide their compensation information. The SEP IRA calculator will use this information to calculate how much you’ll be required to contribute to your employee accounts based on your own contribution rate.
SEP IRA Calculator Outputs
Based on your inputs, the free SEP IRA calculator above determines your SEP IRA contribution limit, which is 25 percent of taxable income up to $55,000. The calculator also provides a suggested SEP contribution amount as well as the required contributions for any employees based on your employer contribution rate.
The four outputs for this SEP IRA calculator are:
1. Maximum Employer SEP IRA Contribution
The first and most important output provided by the SEP IRA calculator is your maximum SEP IRA contribution based on your income. The calculator determines your maximum contributions based on your income, as SEP contributions are limited to 25 percent of taxable income or $55,000—whichever is less.
2. Suggested Employer SEP IRA Contribution
Once the SEP IRA calculator has determined your personalized contribution limit, the calculator uses this number to produce a suggested employer SEP IRA contribution limit. This suggested contribution will equal the desired contribution you provided unless your desired contribution exceeds your contribution limit, in which case your suggested contribution will equal your contribution limit.
3. Required Employee SEP IRA Contributions
If you indicated that you have employees and provided their annual compensation amounts, the calculator will use your suggested contribution rate as a percentage of your income to show how much you’ll be required to contribute to your employees’ accounts. If these contributions are too high, you can lower your desired contribution on the inputs page.
4. Employer SEP IRA 5-Year Growth Projection
The final output for this free SEP IRA calculator is a projection of your account value over five years. This projection assumes that you will make the same SEP IRA contributions for each of the next five years and that your account will earn an average annual return of 5 percent.
SEP IRA Calculator Example
To see how the SEP IRA calculator works, let’s consider Scott, a technology worker who recently started his own company. Scott’s company has started making significant revenue. His personal taxable income is $180,000 per year and he’s thinking about starting a SEP so he can make large pre-tax contributions.
Using the SEP IRA contribution calculator above, let’s see how much Scott can contribute as his income contributes to grow.
SEP IRA Contribution Limits
Based on Scott’s high level of income, his SEP IRA contribution limits will be 25 percent of his taxable income until his taxable income exceeds $220,000. Once Scott’s taxable income exceeds $220,000 his SEP contribution limits will remain $55,000.
“A SEP IRA allows employers to make retirement plan contributions to their employees, or self-employed individuals to make retirement plan contributions for themselves. You can still create a SEP IRA for self-employment even if you’re also an employee with a workplace retirement plan. Your SEP IRA contribution amount is determined annually based on your income. Contributions can be up to 25 percent of net compensation. For 2018, total contribution for one individual cannot exceed $55,000.”
– Josh Zimmelman, President, Westwood Tax & Consulting
Assuming that Scott can continue making these contributions each year and achieve a modest 5 percent average annual return in his account, he should expect his account to grow to over $300,000 within five years.
SEP IRA Contribution Employee Example
Let’s assume that Scott has hired two employees to help with his work, and that he’s paying one $40,000 and the other $50,000. Using a SEP IRA, Scott would be required to contribute to each of their accounts based on his personal contribution rate. We can use the SEP IRA calculator above to see how much he’d have to contribute to their accounts.
SEP IRA Employee Contributions
When to Use a SEP IRA Calculator
This free SEP IRA contribution calculator is an ideal tool if you’re thinking about using a SEP and want to know how much you’ll be able to contribute. If you’re thinking about establishing a SEP, the calculator above will tell you how much you can contribute and whether you can contribute your desired amount.
A SEP IRA contribution calculator is also great to use if you already have a SEP and are thinking about hiring employees. Based on how much you contribute to your own account, the calculator will tell you how much you’ll have to contribute to accounts for full-time employees who are eligible for your SEP.
Employees who are eligible for SEP IRAs aren’t common. However, if you’re available for a SEP at work and know your employer’s taxable income and their contribution rate, the SEP IRA calculator can help you determine how much you’ll get in SEP IRA contributions. The calculator can also show you how quickly those contributions will grow over five years if you get the same contribution each year.
What’s Not Included in the SEP IRA Calculator
The SEP IRA calculator above can be a valuable tool for employers and employees, but there are some things that aren’t included. For example, the calculator does not have different inputs for different types of employee compensation. To determine employee contributions, you need to input total employee compensation.
Total employee compensation that needs to be included in a SEP IRA calculator includes:
- Employee salary – Employee pre-tax salary is the biggest factor in calculating their SEP IRA contribution.
- Elective contributions to a qualified retirement plan – Any salary deferrals that employees make to another employer-sponsored plan need to be added back into their income to calculate their SEP IRA contributions.
- Bonuses – Any additional commissions or incentive pay needs to be included with total employee compensation.
- Stock compensation – The value of any stock awards or stock options are also included in total employee compensation.
The other item that the SEP IRA contribution calculator does not provide is the optimum employer contribution for tax or planning purposes. The calculator tells an employer whether they can contribute their desired amount or, alternatively, the maximum they can contribute if their desired amount is too high.
Pros & Cons of a SEP IRA
When deciding whether to use a SEP IRA, there are a number of pros and cons that small business owners and self-employed individuals should consider. SEP IRA contribution limits are some of the highest available for retirement benefit accounts. However, using a SEP also requires employers to fund proportional contributions for all employees.
SEP IRA Pros
There are many benefits to using a SEP for self-employed individuals and small business owners who have very few or no employees. Contribution limits for SEPs are much higher than most other retirement accounts and contributions are totally discretionary for employers. SEPs also offer very flexible investment options for account holders.
Some SEP IRA pros to consider include:
- High-dollar contribution limit – Small business owners and self-employed individuals can contribute up to $55,000 to a SEP—much more than other accounts, including a Traditional IRA.
- Discretionary employer contributions – Employers get to decide how much to contribute to a SEP each year.
- No minimum contributions – Using a SEP, employers can skip contributions if they want to.
- Flexible investment options – Account holders can invest in many different things through an IRA.
SEP IRA Cons
In addition to the advantages to using a SEP IRA, there are also several drawbacks that you should consider. This is especially true for small business owners who are required to fund contributions for all employees at the same rate as their own contributions as a percentage of compensation.
Some cons of a SEP IRA include:
- Employers have to pay for employee contributions – The biggest drawback of a SEP is that employers must fund contributions for all eligible employee accounts proportional to contributions they make to their own SEP IRA account.
- Low contributions limits as a percent of income – SEPs have high contribution limits in dollar terms ($55,000), but contributions are limited to 25 percent of income. Using a Solo 401(k) allows you to contribute a higher percentage of your income.
- Can’t borrow against assets in a SEP IRA – Unlike a 401(k), you can’t borrow against an IRA, including a SEP.
SEP IRA Alternatives
If you’re an employee, you don’t get to decide whether you have a SEP—your employer either offers one or they don’t. However, while a SEP IRA is very valuable for certain self-employed individuals and small business owners, it isn’t always appropriate. Some business owners may find a 401(k) or other types of IRAs are better.
Four of the most common SEP IRA alternatives are:
1. SIMPLE IRA
A SIMPLE IRA is structured very similarly to a 401(k), but without the administrative costs. Using a SIMPLE IRA, employees make up to $25,000 in pre-tax salary deferrals that employers must match up to 3 percent of employee compensation. For more information on how they work, check out our ultimate guide to SIMPLE IRAs.
SIMPLE IRAs are ideal for employers who don’t want to fund employer contributions. Instead, SIMPLE IRAs allow employers to incentivize employee saving by matching employee contributions. What’s more, SIMPLE IRAs allow employers to avoid the administrative costs of a 401(k).
2. Traditional IRA
A Traditional IRA is the simplest and most straightforward retirement benefit account available. Traditional IRAs aren’t employer-sponsored—anyone who’s eligible can set one up on their own. Using a Traditional IRA, investors can make up to $5,500 per year in pre-tax contributions.
A Traditional IRA is a great account for freelancers, independent contractors, and small business owners who are just starting out and still don’t have much revenue. The contribution limits for Traditional IRAs are very low, but account holders can make contributions when they choose and they don’t have to fund contributions for any employees.
3. Roth IRA
A Roth IRA is different from other alternatives because contributions to a Roth account aren’t tax-deductible. Instead, account holders must still pay income tax on any funds they put in a Roth IRA. In order to contribute to a Roth IRA, you must also meet strict Roth IRA income limits. You can learn more about these limits and how to use a Roth in our ultimate guide to Roth IRAs.
Roth IRAs have a number of unique advantages that make them ideal for long-term tax or estate planning. Roth IRA withdrawals after 59½ are tax-free, and Roths aren’t subject to required minimum distributions after age 70½. This makes a Roth IRA ideal for investors who want to minimize their taxes in retirement.
4. Solo 401(k)
A Solo 401(k) is structured like any other 401(k) plan except that it only has one participant. Because these plans only have one participant (the employer), they are subject to different requirements than normal 401(k) plans and the investment options are broader.
Solo 401(k)s are great for self-employed individuals and small business owners who have no full-time employees and high profitability. Using a Solo 401(k), these investors can contribute up to 100 percent of their taxable income (after self-employment tax) or $55,000—whichever is less. While this is the same dollar limit as a SEP IRAs, it allows account holders to contribute a larger percentage of their income.
If you think a Solo 401(k) may be right for you, you can learn more about who offers Solo 401(k)s, their costs, and investment options. To learn more, be sure to check out our guide to the Best Solo 401(k) Providers.
The free SEP IRA calculator above is a great tool for self-employed individuals and small business owners who are thinking about setting up a SEP IRA or want to know how much they can contribute to their SEP. The tool is also helpful for people with employees who want to know how much they can expect in SEP IRA contributions.
If you’re self-employed or a small business owner and you’re thinking about setting up a SEP IRA, be sure to read about some of the firms that provide these accounts.