If you are self-employed, and looking for one of the most generous retirement plans possible, you need to consider a SEP IRA. This type of plan is best for self-employed individuals or small business owners with no employees.
At its core, it’s an IRA, but it allows for much larger contributions and tax deductions than a traditional IRA. More formally known as the Simplified Employee Pension Plan IRA, it’s one of the best self-employment retirement plans available due to the bigger savings opportunities both in your retirement account and in tax savings.
How Does a SEP IRA Work?
SEP IRAs work much like traditional IRAs. Your contributions may be tax-deductible and the money can be invested in a self-directed account. Investment earnings accumulate on a tax-deferred basis and can be withdrawn beginning at age 59 and a half. The biggest difference between the two plans is the contribution limit and catch up contributions. With a traditional IRA, your contributions are limited to no more than $6,000 per year, or $7,000 if you’re 50 or older (for 2019). However, a SEP IRA doesn’t allow an additional catch up contribution for those 50 and older. SEP IRA contributions allow for the lesser of either 25% of your compensation or $56,000 for 2019 ($55,000 in 2018).
How to Start a SEP IRA
One of the big advantages of a SEP IRA is that it’s simple to set up and manage given there’s no complicated paperwork involved in the process. Here are the basic requirements for implementing the SEP IRA:
- Begin the process by choosing a trustee to manage the plan. That could be a bank, a mutual fund family, a brokerage firm, or a robo-advisor.
- Create a written agreement, spelling out the details of the benefits of the plan. The IRS provides Form 5305-SEP, Simplified Employee Pension-Individual Retirement Accounts Contribution Agreement which simplifies the process. Also, it’s likely the trustee will be able to provide any necessary paperwork, including a pro forma for the plan to help you with the written set up process.
Making Contributions to Your SEP IRA
Another major advantage of a SEP IRA – being that it’s an IRA account – is that you can open a fully self-directed account. That means you can invest in a full-service brokerage firm and trade in just about any investments you choose. You can also choose to hold the plan in a managed option, like a robo-advisor. Just like with traditional and Roth IRAs, you can make a contribution to your plan for the previous year as late as the tax deadline for that tax year.
Roth SEP IRA. Remember we said that there is no catch-up contribution on a SEP IRA for taxpayers 50 and older? There’s also no catch up for Roth SEP IRAs. However, if you earn within the income limits to make a Roth IRA contribution, you can set up a separate Roth IRA. You can contribute to that plan, as long as, when combined with your SEP contributions, you don’t exceed $56,000, the contribution will be permitted.
Should You Open a SEP IRA for Your Business?
Obviously, the biggest advantage to a SEP IRA is the much higher contribution limit allowed compared to a traditional or Roth IRA. It will not only allow you to accumulate a much larger retirement plan more quickly, but it may also provide you with a very generous tax break.
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