Small business owners can offer employees (and themselves) a tax-deferred retirement savings plan similar to the plans offered by larger corporations—but without incurring the high start-up and operating costs of a conventional retirement savings plan such as a 401(k).
A simplified employee pension (SEP) plan is similar to corporate retirement plans such as 401(k)s in that:
- Both are funded with pre-tax contributions
- Investments within both plans grow tax-deferred
- Withdrawals in retirement are taxed at your ordinary income rate in the year of the withdrawal
However, there are also some important differences. While 401(k) plans are funded with pre-tax compensation from employees (sometimes supplemented with a full or partial match by the employer), all contributions made to a SEP plan must come from the employer on behalf of the employees. Although a SEP plan is funded with after tax dollars, employer contributions are a deductible business expense.
An employer could make an annual contribution of up to the lesser of 25%1 of each employee’s compensation2 or $69,000 (whichever is less) for 2024 and $70,000 for 2025.