SEP IRA, which stands for Simplified Employee Pension Individual Retirement Arrangement, offers several benefits, especially for business owners and self-employed individuals.
Here are the top three benefits:
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Higher Contribution Limits: One of the most significant benefits of a SEP IRA is the elevated contribution limit. For 2023, the contribution limit is the lesser of 25% of compensation or $66,000. This is substantially higher than the contribution limits for traditional or Roth IRAs, making it an attractive option for business owners and self-employed individuals who want to save a significant amount for retirement.
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Tax Deductible: Contributions to a SEP IRA are tax-deductible, which can provide a substantial reduction in taxable income for the year the contributions are made. Additionally, investments grow tax-deferred until withdrawal, which can have a positive impact on long-term investment growth due to the power of compounding.
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Flexibility in Contributions: Business owners have flexibility regarding contributions to a SEP IRA. In years when the business is thriving, they can contribute more, up to the annual limit. During leaner years, they can reduce the contribution amount or choose not to contribute at all without penalty. This flexibility is particularly advantageous for businesses with fluctuating income.
These benefits make the SEP IRA a powerful tool for retirement savings, especially for those who are self-employed or run small businesses with a few or no employees.
Managing a SEP IRA (Simplified Employee Pension Individual Retirement Account) for your firm requires a strategic approach to maximize your contributions while adhering to IRS rules and deadlines.
SEP IRA vs. SIMPLE IRA
As a business owner, the thought of retirement planning for yourself and your employees can be as daunting as it is essential. You want a plan that’s beneficial yet straightforward, without overwhelming costs or administrative hassle. If you’re considering retirement options beyond the conventional 401(k), you may find yourself weighing the merits of SEP IRAs against SIMPLE IRAs. These plans are popular alternatives, offering unique advantages depending on your business’s needs. This article will help you understand the critical differences between SEP and SIMPLE IRAs to make an informed decision.
Understanding SEP IRAs for Business Owners
A SEP IRA, or Simplified Employee Pension Individual Retirement Arrangement, is often lauded for its high contribution limits and ease of setup. It’s an excellent option for self-employed individuals or small business owners with few or no employees. If your goal is to maximize your retirement savings, the SEP IRA allows contributions of up to 25% of each employee’s pay (subject to annual limits), which for 2023 is $66,000.
The SIMPLE IRA: Streamlined Savings for You and Your Employees
On the other hand, a SIMPLE IRA – Savings Incentive Match PLan for Employees – is better suited for businesses with fewer than 100 employees. It encourages both employer and employee contributions, with lower set-up and maintenance costs compared to a SEP IRA or 401(k). For 2023, the contribution limit for employees is $15,500, with a catch-up contribution of $3,000 for those over 50.
SEP vs. SIMPLE IRA: Tailoring the Choice to Your Business
Choosing between a SEP and a SIMPLE IRA depends on several factors unique to your business:
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Business Owner Goals and Preferences: Consider whether your priority is to maximize your contributions or to encourage employee savings as well.
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Size of Business / Employee Headcount: A SEP IRA is often more flexible for businesses with variable employee numbers, while a SIMPLE IRA is optimal for stable businesses with a consistent headcount under 100 employees.
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Employer and Employee Ability to Contribute: If you want to incentivize your employees by matching their contributions, a SIMPLE IRA may be the way to go. For higher individual contributions without a matching requirement, consider a SEP.
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Contribution Minimums and Limits: Both plans have mandatory contribution rules. For a SEP, you must contribute equally for all eligible employees, while SIMPLE IRAs require a mandatory match or nonelective contribution.
To assist you in guiding your clients through this complex decision, we’ve developed this . This decision-making tool is designed to streamline the process of analyzing SEP vs. SIMPLE IRAs. It includes key decision points that cover the above factors, enabling you to consider all necessary information and align your business with the most suitable retirement plan.
By understanding the nuances of SEP and SIMPLE IRAs, you can ensure that the retirement plan you choose not only meets your business objectives but also supports your employees’ financial well-being. And remember, the best choice is always the one that aligns closely with your specific business situation and retirement goals.
SEP IRA vs Simple IRA Flowchart –
SEP IRA FAQs
SEP IRA Plans, according to the IRS plan provides business owners with a simplified method to contribute toward their employees’ retirement as well as their own retirement savings. Contributions are made to an Individual Retirement Account or Annuity (IRA) set up for each plan participant (a SEP IRA).
A SEP IRA account is a traditional IRA and follows the same investment, distribution, and rollover rules as traditional IRAs. See the .
See also PDF, and for detailed information on SEP plans and SEP IRAs.
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Distributions (Withdrawals) (same as IRA rules – see )
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Investments (same as IRA rules – see )
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Who can establish a SEP?
Any employer, including self-employed individuals, can establish a SEP.
How do I establish a SEP?
There are three basic steps in setting up a SEP, all of which must be satisfied.
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Adopt a formal written agreement by signing one of these documents:
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IRS model SEP using PDF;
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IRS-approved prototype SEP, offered by banks, insurance companies, and other qualified financial institutions; or
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individually designed SEP plan document.
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Provide each eligible employee with information about the SEP. If you established the SEP using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions and the other information listed in the Form 5305-SEP instructions. If you used a prototype SEP or individually designed SEP, you must provide similar information.
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Set up a SEP IRA for each eligible employee with a bank, insurance company or other qualified financial institution. The employee owns and controls the SEP IRA.
Is there a deadline to set up a SEP?
You can set up a SEP plan for a year as late as the due date (including extensions) of your business’s income tax return for that year.
If I have a SEP, can I also have other retirement plans?
You can maintain both a SEP and another plan. However, unless the other plan is also a SEP, you cannot use Form 5305-SEP; you must adopt either a prototype SEP or an individually designed SEP.
Can I set up a SEP for my self-employment income if I participate in my employer’s retirement plan?
Yes, you can set up a SEP for your self-employed business even if you participate in your employer’s retirement plan at a second job.
Can each partner in a partnership maintain a separate SEP plan?
No, only an employer can maintain and contribute to a SEP plan for its employees. For retirement plan purposes, each partner or member of an LLC taxed as a partnership is an employee of the partnership.
Do I need to update my SEP plan?
It is your responsibility to ensure that you keep your plan up-to-date with current law. If you set up your plan with a prototype plan document, you should have received an amended plan from the financial institution that provided it. If you didn’t receive a new plan document, contact the financial institution. If you set up your plan with Form 5305-SEP, adopt a new form when the IRS updates it. See the instructions to PDF.
Can each of my employees choose a different financial institution for his or her SEP IRA?
Although the law does not require each participant’s SEP IRA to be at the same financial institution, the institution that offers or administers the SEP may require you to deposit SEP contributions initially into SEP IRAs maintained at that institution.
Which employees are eligible to participate in my SEP plan?
Employees must be included in the SEP plan if they have:
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attained age 21;
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worked for your business in at least 3 of the last 5 years;
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received at least from your business for the year.
Your plan may use less restrictive requirements, for example age 18 or three months of service, to determine which employees are eligible.
Are the eligibility requirements the same for all employees in a SEP plan, including owners?
Yes. The eligibility provisions stated in the SEP plan document must apply equally to owners and employees.
My spouse and I own our business. Must we both meet the SEP plan eligibility requirements to receive a plan contribution?
Yes. Each of you must separately meet the plan eligibility requirements to participate.
I’d like to establish a SEP plan that allows me to participate immediately. Can I establish different SEP plan eligibility requirements for future employees?
Yes. You can initially establish your SEP plan so that you are immediately eligible to participate in the plan. Later, you can amend the plan to have more restrictive eligibility requirements, but you must also meet the new eligibility requirements to continue your participation in the plan.
What is the 3-of-5 rule?
The 3-of-5 eligibility rule means you must include any employee in your plan who has worked for you in any 3 of the last 5 years (as long as the employee has satisfied the other plan eligibility requirements). This is the most restrictive eligibility requirement allowable. You can choose to use less restrictive participation rules in your plan, such as allowing employees to participate immediately after they start work or after a shorter period of employment (for example, after working for only 1 year).
If you use the 3-of-5 rule, you must count any work, no matter how little, in each of the prior 5 years. Use plan years (often the calendar year), not years based on the date the employee started working for you.
Example: Your SEP plan uses the 3-of-5 eligibility rule, uses a calendar year and has no age or compensation requirements. To be eligible for a contribution for 2019, an employee must have worked for you for any length of time in any 3 years in the 5-year period from 2014 to 2018. An employee who worked for you for two months in 2014, 2016 and 2018 must share in the SEP contribution made for 2019.
If you didn’t include an employee who worked for you in 3 out of the last 5 years, or if you didn’t follow your SEP plan’s participation requirements, find out how you can this mistake.
Is my new employee eligible to participate in our SEP plan immediately?
It depends on your SEP plan’s eligibility requirements. Review your plan document to determine the plan’s eligibility requirements.
If our SEP plan document includes the 3-of-5 eligibility rule, do we have to make a 2019 SEP plan contribution for an employee who was hired in December 2016?
Yes, if the employee meets all the other eligibility requirements of your plan, a SEP contribution is required for 2019 for any employee who worked for you for any length of time in 2016, 2017 and 2018.
Years are counted based on the plan year (usually the calendar year), not from the date the employee started working for you.
If our SEP plan’s only eligibility requirement is age 21, can we prorate an employee’s compensation from the date he turns 21 for his SEP contribution for that year?
No. You must base the employee’s SEP plan contribution on the employee’s entire plan-year compensation.
Our SEP plan requires employees to earn at least $650 in compensation for the year to participate in the plan. Can we prorate an employee’s compensation from the date he earns more than $650 in the year for that year’s SEP contribution?
No. Once the employee earns at least $650 in 2021 or in 2022 ($600 in 2020 and 2019) in a year and meets any other plan eligibility requirements, you must base the employee’s SEP plan contribution on the employee’s entire plan-year compensation.
Which categories of employees may I exclude from my SEP plan?
You may choose to exclude employees who are:
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covered by a union agreement if retirement benefits were bargained for in good faith by you and the employees’ union; or
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nonresident aliens who have no U.S. source compensation.
As discussed above, you may also choose to exclude employees who have not met the minimum requirements for age, time of service, or compensation received.
If you excluded employees who should have been included in your SEP plan, find out how you can this mistake.
What happens if an employee elects not to participate?
An employer may establish a SEP IRA for an employee who is entitled to a contribution under the SEP plan if the employee is unable or unwilling to establish a SEP IRA.
What compensation is included in determining SEP contributions for an employee?
For an individual who is not self-employed, compensation used to determine SEP contributions generally includes: wages, salaries, tips, overtime, bonuses, commissions, vacation and sick pay, fees, and other remuneration from the employer for services performed.
Compensation does not include severance pay, nontaxable fringe benefits, or worker’s compensation.
Compensation is limited to $330,000 in 2023, $305,000 in 2022, $290,000 in 2021 and $285,000 in 2020.
Refer to your written SEP agreement for more information.
What compensation is included in determining SEP contributions for a self-employed individual?
For purposes of the SEP plan rules, a self-employed individual’s compensation means net earnings from self-employment determined under Internal Revenue Code section 1402(a).
How much can I contribute to my SEP?
The contributions you make to each employee’s SEP IRA each year cannot exceed the lesser of:
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25% of compensation, or
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$66,000 for 2023 ($61,000 for 2022; $58,000 for 2021; $57,000 for 2020 and subject to annual for later years).
These limits apply to contributions you make for your employees to all defined contribution plans, which includes SEPs. Compensation up to $330,000 in 2023 ($305,000 in 2022; $290,000 in 2021; $285,000 in 2020 and subject to cost-of-living adjustments for later years) of an employee’s compensation may be considered. If you’re self-employed, use a special calculation to determine .
Contributions must be made in cash; you cannot contribute property.
If you’ve contributed more than the annual limits to your SEP plan, find out how to this mistake.
How much can I contribute if I’m self-employed?
The same limits on contributions made to employees’ SEP IRAs also apply to contributions if you are self-employed. However, special rules apply when figuring the maximum deductible contribution. See for details on determining the contribution amount.
Must I contribute the same percentage of salary for all participants?
Most SEPs, including the IRS model Form 5305-SEP, require you to make allocations proportional to your employees’ salary/wages. This means that everyone’s contribution is the same percentage of salary.
If you haven’t made contributions to participants’ SEP IRAs equal to the same percentage of each participant’s compensation, find out how you can this mistake.
If you are self-employed, base your contribution on net profit – minus one-half of the self-employment tax – minus your SEP contribution. See on determining the contribution amount.
If I participate in a SEP plan, can I also make tax-deductible traditional IRA contributions to my SEP IRA?
If the SEP IRA permits non-SEP contributions, you can make regular IRA contributions (including IRA catch-up contributions if you are age 50 and older) to your SEP IRA, up to the maximum . However, the amount of the regular IRA contribution that you can on your income tax return may be reduced or eliminated due to your participation in the SEP plan.
If I participate in a SEP plan, can I contribute to a Roth IRA in addition to receiving contributions under the SEP plan?
A SEP IRA is a traditional IRA that holds contributions made by an employer under a SEP plan. You can both receive employer contributions to a SEP IRA and make regular, annual contributions to a traditional or Roth IRA. Employer contributions made under a SEP plan do not affect the amount you can contribute to an IRA on your own behalf.
Because a SEP IRA is a traditional IRA, you may be able to make regular, annual IRA contributions to this IRA, rather than opening a separate IRA account. However, any dollars you contribute to the SEP IRA will reduce the amount you can contribute to other IRAs, including Roth IRAs, for the year.
Example 1: Nancy’s employer, JJ Handyman, contributes $5,000 to Nancy’s SEP IRA at ABC Investment Co. based on the terms of the JJ Handyman SEP plan. Nancy, age 45, is permitted to make traditional IRA contributions to her SEP IRA account at ABC Investment Co., and she contributes $3,000 in 2019. If Nancy also wants to contribute to her Roth IRA at XYZ Investment Co. for 2019, she can contribute $3,000 ($6,000 maximum contribution less the $3,000 already contributed to her SEP IRA) by April 15, 2020.
Example 2: Nancy, age 45, is the owner and sole employee of JJ Investment Advisors. Nancy contributes the maximum allowable amount to her SEP IRA for 2019, or $56,000. Nancy may also make regular, annual IRA contributions to her SEP IRA, if her SEP IRA allows this, or contribute to her Roth IRA at XYZ Investment Co. Her total traditional IRA and Roth IRA contributions cannot exceed $6,000 for 2019 and may be made in addition to her SEP contributions.
Can I make catch-up contributions to my SEP?
No, SEPs are funded by employer contributions only. Catch-up contributions apply only to employee elective deferrals. However, if you are permitted to make traditional IRA contributions to your SEP IRA account, you may be able to make .
Must I contribute to the SEP every year?
No, you are not required to contribute every year. In years you do contribute to the SEP, the contributions must be made to the SEP IRAs of all eligible employees.
Do I have to contribute for a participant who is no longer employed on the last day of the year?
Yes, you do, if they are otherwise eligible for a contribution. A SEP cannot have a last-day-of-the-year employment requirement. If the employee is otherwise eligible, they must share in any SEP contribution. This includes eligible employees who die or quit working before the contribution is made. If you haven’t made a contribution for an eligible employee in your SEP plan, find out how you can this mistake.
Can I contribute to the SEP IRA of a participant over age 70 ½?
You must contribute for each employee eligible to participate in your SEP, even if they are over age 70 ½. The employee must also take minimum distributions, however. If you haven’t contributed for an eligible employee in your SEP plan, find out how you can this mistake.
When must I deposit the contributions into the SEP IRAs?
You must deposit contributions for a year by the due date (including extensions) for filing your federal income tax return for the year. If you obtain an extension for filing your tax return, you have until the end of that extension period to deposit the contribution, regardless of when you actually file the return.
If you did not request an extension to file your tax return and did not deposit the SEP plan contributions by the filing due date for that return, you are not allowed to deduct any SEP plan contributions on that year’s return. The contributions may be deducted on the following year’s return.
If you improperly deducted SEP plan contributions on your return, you must file an amended tax return as soon as possible.
How much of the SEP contributions are deductible?
The most you can deduct on your business’s tax return for contributions to your employees’ SEP IRAs is the lesser of your contributions or 25% of compensation. (Compensation considered for each employee is limited and subject to annual ). If you are self-employed and contribute to your own SEP IRA, there is a special computation to figure the .
Are employer contributions taxable to employees?
No, contributions to employees’ SEP IRAs are not included in their gross income, unless they are excess contributions.
What are the consequences to employees if I make excess contributions?
Excess contributions are included in employees’ gross income. Employees who withdraw the excess contribution (plus earnings) before the due date for their federal return, including extensions, will avoid the 6% excise tax imposed on excess SEP contributions in an IRA. Excess contributions left in the employee’s SEP IRA after that time will be subject to the 6% tax on the employees’ IRAs, and the employer may be subject to a 10% excise tax on the excess nondeductible contributions. If you’ve contributed too much to your employees’ SEP IRA, find out how you can this mistake.
If my SEP plan fails to meet the SEP requirements, are the tax benefits for me and my employees lost?
Generally, tax benefits are lost if the SEP fails to satisfy the Internal Revenue Code requirements. However, you can retain the tax benefits if you use one of the to correct the failure. In general, your correction should put employees in the position they would have been had the failure not occurred.
Why is last year’s contribution that was made this year for the SEP IRA shown on this year’s Form 5498 instead of last year’s Form 5498?
The IRS requires contributions to a SEP IRA to be reported on the Form 5498 for the year they are actually deposited to the account, regardless of the year for which they are made.
Do I need to amend my SEP for the new law before I terminate it?
Generally, the IRS has not required employers to amend their SEPs for new law prior to termination. Check with your plan professional.
Do I have to fund my SEP in the year of termination?
SEPs can be terminated at any time. You can stop funding your plan once it is terminated.
What are the notification requirements when a SEP terminates?
When you terminate your SEP plan, it is a good idea to notify the employees that you are discontinuing the plan. You may need to notify the financial institution that you chose to handle the plan that there will be no more contributions and that you will terminate the contract or agreement with it. Do not notify the IRS of the plan’s termination.
If I go out of business or my employee terminates service, can the amount in a SEP IRA be left untouched?
Yes.
Have a question about retirement plans? .
SEP IRA Funny Tweets
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🤑 Why did the small business owner open a SEP IRA? To invest in his favorite startup: Himself! #SEP_IRA #SoloPreneur
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🎩💼 I told my SEP IRA I was seeing other investments on the side… now my stocks are jealous! #InvestmentDrama #SEPlove
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👵🧓 Planning for retirement with a SEP IRA is like expecting a great party; you better stock up early so it’s a blast! #RetireInStyle #SEPIRAFun
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📈 Every time I contribute to my SEP IRA, I feel like I’m buying a piece of my future beach house. 🏖️ #FutureMeThanksMe #SEPvibes
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🐷💰I told my piggy bank about my SEP IRA… it’s not speaking to me anymore. #SEPWins #PiggyBankEnvy
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🏝️🍹 Contributing to a SEP IRA is like sending your future self on a tropical vacation. Don’t be stingy! #RetirementGoals #SEPSavings
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🌱 Every SEP IRA contribution is like watering your money tree. Let’s grow this green! #MoneyTree #SEPgrowth
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🧙♂️✨ If retirement planning with a SEP IRA is magic, then I’m ready to be the financial wizard! 🪄 #RetirementWizardry #SEPmagic
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🐣👵 Turning a small SEP IRA into a big nest egg is the best kind of #GlowUp. #NestEggGoals #SEPIRAChick
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🎣👴 They say the best time to start a SEP IRA was yesterday. The second-best time? Today, before you go fishing! #ProcrastinationNation #SEPStart
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🚀💸 I like my coffee black and my SEP IRA fully funded. To the moon! #RetirementRocket #CaffeinateAndContribute
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🤖 Warning: my SEP IRA is on autopilot, and it’s set to ‘crush retirement goals.’ #RoboRetirement #SEPAutopilot
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💡🎈 When I contribute to my SEP IRA, it feels like I’m throwing a surprise party for Future Me. Surprise, we’re rich! #SurpriseWealth #SEPFun
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🏋️♂️ My SEP IRA isn’t just a savings account, it’s a financial workout for my wallet! #FlexThoseDollars #MoneyMuscles
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🦄 Just found out my SEP IRA contributions are tax-deductible. Is this what finding a unicorn feels like? #TaxUnicorn #SEPPerks
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🎮 Leveling up my SEP IRA so retirement doesn’t mean game over. #RetirementGameStrong #SEPIRALevels
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🎭 My SEP IRA has more drama than my favorite soap opera. Will the market go up? Will it go down? Stay tuned! #MarketSuspense #SEPStories
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🎨 My SEP IRA is the canvas, and my contributions are the paint. Let’s make a retirement masterpiece! #RetirementArt #SEPCreations
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📚 My SEP IRA said it wanted to be a novel, not a short story. So I’m writing long chapters with my contributions! #StoryOfWealth #SEPAuthors
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🌟 Behind every successful small business owner is a robust SEP IRA shining bright. #FinancialSuperstar #SEPBrightFuture
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🕵️♂️ Shhh… my SEP IRA is on a secret mission to multiply my money! #MoneyMissionImpossible #SEPspionage
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🛌 Dreaming about my retirement with my eyes open because my SEP IRA is on point. #DaydreamingForProfit #SEPnapTime
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🎤 My SEP IRA contributions are my retirement mixtape. Dropping hits every year! #RetirementDJ #SEPBeats
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🌮 Every taco I skip today is an extra guac in my SEP IRA tomorrow. #GuacAndRoll #SaveThatTacoMoney
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