When you’re self-employed or running a small business, you likely spend a lot more time hustling than you do thinking about retirement. After all, you're not at a big company where there are retirement options for employees like a 401(k). Plus, there probably aren't many retirement savings options out there for business like yours, right?
There's something called a SEP IRA. What is a SEP IRA, you ask? Let's find out...
What is a SEP IRA?
Here’s how the IRS describes the SEP IRA: “A Simplified Employee Pension (SEP) 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.”
In other words, a SEP IRA is a retirement plan meant for those with self-employment income. It works just like a traditional IRA account, but it does have specific rules.
If You Are A Sole Proprietor
If you are the only employee of your business, the SEP IRA is ideal. It works like this: You can contribute up to 25 percent of the business' income, maxing out at $53,000 a year in 2015. This is great news because traditional IRAs contributions cap out at $5,500 a year. So, if you are starting your retirement savings a bit late, the SEP IRA will allow you to save more, faster. You can also have separate traditional IRA accounts at the same time as an SEP IRA. But—and this is a big but—if you add employees to your business, you will need to contribute the same percentage to their SEP-IRA as well.
From an accounting perspective, contributions to your SEP IRA will reduce your bottom line, but in a good way! You'll have money socked away for the future, and your business' tax exposure will be less.
If You Are A Small Business Owner With Employees
Here is where the SEP IRA gets a bit tricky. Employees cannot contribute their own income to the SEP IRA account. Their contribution comes only from the business, and the percentage must match what the business owner (aka, you) contribute to your own SEP IRA. So if you’ve made the decision to contribute 20 percent of the business' income to your SEP IRA, you will also have to contribute the same amount to your employees' SEP IRAs—and that's above and beyond their salary. The good news is that you do not have to contribute anything at all. If it’s a lean year, you can skip contributing. If it’s been a banner year, you can contribute a hefty amount and get a lovely tax break at the same time. For the record, this does not apply to your 1099s—you do not need to contribute to the SEP IRA for them.
Setting Up a SEP IRA
Setting up a SEP IRA couldn’t be easier. You can establish an account for the previous year up until April 15th of the next year (in other words, there is still time to set up your 2014 account). Use the 5305-SEP form from the IRS and open up an account with your local bank or credit union. You chose how to invest the funds from your SEP IRA as well. You can choose stocks, mutual funds, or money market accounts. And as with most retirement vehicles, there is a penalty (10 percent for SEP IRAs) if you withdraw from the account before you're 60. A financial advisor can be particularly useful in setting up a SEP IRA.
So think about it! A SEP IRA can be super-useful when it comes to self-employed retirement planning.
As usual, nothing in this post should be considered tax or financial advice. Always talk to a specialist!