So how do you maximize your SEP IRA contribution? I have always believed that the United States Tax Code has been favorable to business owners. A SEP IRA is a brilliant way to put more money back in your pocket compared to what you would be allowed as an employee working for someone else somewhere.
You are allowed to stash away 20% of your income each year (in 2010 this was a max of $49,900 which is huge). The best part about this is that if you are employed and have a 401k plan at work, you can maximize your SEP IRA contributions through your side business. To give you some perspective, contribution to a Traditional or Roth IRA in the same year was capped off at $5,000. A 401k between $15,000 and $16,000, both much lower than the SEP IRA contribution limits.
Even as a part time self-employed individual (for example if you have a side business), you have the ability to establish a SEP and therefore maximize your SEP contribution and tax benefits. Look at it as just another retirement account vehicle where you are allowed to put more money compared to a traditional retirement plan with your employer. Just like any other IRA, a SEP contribution you make today accumulates tax free over the years. You are not taxed until you take your money out later at the age of 59 and a half.
So, if you are an employee, running a side business is advantageous to you because you have the opportunity to maximize your SEP contribution. So, while your colleagues are settling for the meager 401k contribution limits, you on the other hand are stashing more away for retirement by maximizing your IRA contributions.
SEP IRA Contribution Example Sounds good in theory, right? Let's examine a more practical example to see how your IRA contributions fare against the traditional 401k retirement plan. Assume you are a mid-aged, employed individual who makes a $70,000 income per year. If this income is from your business, according to the IRA rules, you could stash away $14,000 at a 20% contribution rate. On the other hand, if this income is from employment, you could contribute up to $16,500 to a traditional 401k plan (older folks can put away $22,000 as of 2011).
But now what if you make $100,000 a year? Based on the IRA contribution rules, you can stash away $20,000 (still the 20% rate) whereas a 401k plan at work would only allow you the same $16,500, adjusted each year based on new laws and regulations. So, as you can tell, the more you progress in the income ladder, the more the gap becomes between what you can put into a SEP IRA compared to a traditional 401k plan through your employer.
I know the calculation may not be this simple and straight forward in all cases, but you get the point. This is why I am a big advocate of the SEP IRA plan. The beauty of it is that you can own one on the side in addition to a 401k plan if you own a profitable side business. Notice I mentioned profitable. You cannot engage in SEP IRA contributions if your business is not making money. YOU WILL GET IN TROUBLE if you try to pull any stunts.
So, to maximize your SEP IRA contributions and the benefits from it, put in as much as you can now to reduce your taxes today, and at the same time save up for your golden years.
Note to Employees: Keep the following criteria in mind to determine whether you are eligible to contribute to a IRA plan:
- You must be 21 years or age or older.
- You must have at least $550 in annual income (check on this as the amount may changes when you read this).
- Must have worked for the employer providing the SEP for 3 of the last 5 years.
In addition, it is important to remember the compensation rules and requirements. Employees under the common law whose wages are reported on form W2 are eligible, however only up till $245,000 of your income is eligible for consideration under a SEP contribution.
Unionized employees who are already provided a retirement vehicle under a collective bargaining agreement are not eligible to participate in SEP IRA contributions. These rules only apply to legal US residents or green card holders as well as citizens. Non-permanent residents are not eligible for SEP IRA contribution.
Note to Employers: While you are allowed to establish age eligibility requirements for your SEP IRA plan, you must be careful not to set this limit where it precludes you from contributing to the SEP IRA. Everyone contributing to a SEP IRA under the same plan are treated equally the same, whether employer or employee.
Here is a brief guide that shows you what income qualifies for SEP contribution based on the type of business you own:
- Sole Proprietorship - income reported on Schedule C of your tax return
- Partnership - income reported on Schedule K-1 of your tax return.
- LLC - Limited Liability Corporation - income reported on Schedule C of your tax return
Curt Matsen, CPA is the author of the SEP IRA Guide, a comprehensive blog on what a SEP IRA is, contribution limits, rules, laws and regulations. Read more at: [http://www.sepirahq.com]
Article Source: https://EzineArticles.com/expert/Curt_Matsen/1044274
Understand your contribution limits: The amount you can contribute to a SEP IRA each year is limited by law. For 2021, the contribution limit is $58,000 or 25% of your net self-employment income, whichever is lower. It's important to understand these limits so you can plan your contributions accordingly.
Contribute as early as possible: The earlier you start contributing to your SEP IRA, the more time your money has to grow tax deferred. Additionally, the sooner you start saving, the more you can potentially contribute over time.
Contribute consistently: Consistently contributing to your SEP IRA on a regular basis, whether it's monthly, quarterly, or annually, can help you build a solid foundation for your retirement savings.
Consider increasing your contributions: If you are able to, consider increasing your contributions over time as your business or income grows. This can help you take full advantage of the contribution limits and ensure that you are saving as much as possible for retirement.
Make catch-up contributions: If you are age 50 or older, you may be eligible to make catch-up contributions to your SEP IRA. These additional contributions can help you boost your retirement savings and make up for any ground you may have lost earlier in your career.
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