This Retirement Account for Small Businesses Lets You Save More Than a Traditional or Roth IRA

It's a savings option worth looking into.

There's a reason workers are told how important it is to save money for retirement. Social Security won't replace all of your pre-retirement wages -- not even close. And those benefits are at risk of cuts in the future if lawmakers don't address the program's impending financial shortfall.

As such, it's essential that you take retirement savings into your own hands. And as a small business owner, you have a few different options to look at.

You could house your retirement savings in a traditional IRA or a Roth IRA. Eligibility for these accounts hinges on having earned income -- that's it. So as long as you've paid yourself something this year, you can put some money into a traditional or Roth IRA.

But traditional and Roth IRAs don't have very high contribution limits. If you're under 50, this year, you're restricted to a maximum contribution of $6,000 in either account. That's why it could pay to look at funding a SEP IRA instead.

Is a SEP IRA right for you?

A SEP IRA, or simplified employee pension IRA, is a tax-advantaged retirement savings plan that's designed for small business owners and those who are self-employed. SEP IRAs are not funded by workers out of their paychecks like 401(k) plans are. Rather, with a SEP IRA, you, as a business owner, contribute funds for yourself as well as your employees.

Like traditional IRA contributions, SEP IRA contributions go in tax-free. And so they serve the important purpose of exempting some earnings from taxes.

But what makes SEP IRAs unique is that they come with much higher annual contribution limits than traditional and Roth IRAs. As mentioned, both of those accounts max out at $6,000 right now if you're under 50. With a SEP IRA, you can put in up to $61,000 this year. And next year, that limit will rise to $66,000 (whereas the contribution limit for traditional and Roth IRAs is only increasing by $500 in 2023).

Is a SEP IRA right for you?

While a SEP IRA gives you an upfront tax break on contributions, your withdrawals in retirement are taxable. If you want to enjoy tax-free retirement withdrawals from your savings, you'll need to look at a Roth IRA instead. But if you want to contribute more money toward your retirement, then a SEP IRA is a good option to explore given its more generous contribution limit.

That said, one thing you should know about SEP IRAs is that you're required to contribute to your employees' accounts at the same rate you contribute to yours. If you contribute 10% of your own salary to your SEP, and you have three employees, you have to contribute 10% of their salaries, too.

That's why a SEP IRA isn't always a great option for small business owners who employ a lot of people. But if you're the sole employee at your business, or you only employ a handful of people, then it's a retirement savings account worth looking into.