SEPs contain only employer contributions, and they must contribute the same percentage of every employee’s compensation. As of 2016, an employer may contribute the lesser of either 25% of an employee’s compensation or $53,000 annually.
An important thing to note is that the employer decides whether to contribute to the employees’ SEP IRA each year; the employer is not required to make continuous yearly contributions. The equal treatment of all employees with respect to the retirement plans is a fundamental principle of all employer-sponsored retirement programs.
If an owner-employee of a pass-through entity wants to contribute to his own SEP, he may find that his contribution limits are lower than the 25%/ $53,000 limits. This is due to a formula which requires half of the so-called self-employment tax to reduce the amount of income included in the calculation.
The effective contribution limit for sole proprietors is generally about 18.6% of net profit. Please consult a tax professional if you need more clarification. In a sole proprietorship, the owner may be better served by an Individual 401(k) plan, which also has low administrative costs.
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