Self-Employed? Here’s What You Need to Know About SEP IRAs

Self-Employed woman on laptop filing taxes

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 Investment earnings accumulate on a tax-deferred basis and can be withdrawn beginning at age 59 and a half.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 ($57,000 in 2020).

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. When implementing, consider these basic requirements:

  1. 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.
  2. 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. Another advantage is, unlike with traditional and Roth IRAs, you can make a contribution to your plan for the previous year as late as the extended tax deadline for that tax year. So, if you filed a 2019 tax extension and you still need to file by the tax year 2019 extended tax deadline of October 15, you can still contribute to your SEP IRA by the extended deadline and save on your 2019 taxes.

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 contribution 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?

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.

Don’t worry about knowing these tax rules. TurboTax Self-Employed will ask simple questions about you and your business and give you the tax deductions and credits you’re eligible for based on your entries. If you have questions, you can connect live via one-way video to a TurboTax Live Self-Employed CPA or Enrolled Agent with an average 15 years’ experience to get your tax questions answered. TurboTax Live Self-Employed CPAs or Enrolled Agents are available in English and Spanish and can also review, sign, and file your tax return.

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