What is a SEP IRA and Who Can Use It to Save for Retirement?– September 06, 2017 by Nancy Spalding

A SEP, or Simplified Employee Pension Plan, is a type of individual retirement account (IRA) and can be a great retirement savings tool for small business owners and self-employed individuals, the definition of which is broader than you might think. 

What is a SEP IRA?

When you hear IRA, most automatically think traditional or Roth. With both of these vehicles you can only contribute $5,500 per year (or $6,500 per year if age 50 or older), and you can’t contribute after you are 70 ½ years old. With a SEP you can contribute up to 20% of net self-employment income (after deduction for self-employment tax), up to a maximum of $53,000 per year (increasing to $54,000 in 2017). You can continue to contribute after age 70 ½ with no income limits.
 
Another benefit of the SEP is that the plan can be set up and contributed to up until the due date of the return. For a 2017 individual tax return that has been extended, you have until October 15, 2018. 

Who Qualifies for a SEP?

A business owner or otherwise self-employed individual can consider a SEP. But here’s the real twist: Even if you don’t own your own business, you still may qualify as “self-employed” for this purpose. Let’s look at some examples that DO in fact qualify as self-employed income and, therefore, qualify for a SEP: 

  • A practicing physician serves as an expert witness and gives testimony outside of his practice and is paid personally for that work.
  • A business owner sells his company but stays on for five years as a consultant to the new owners.
  • An individual retires and now wants to do something he has always loved: art, music, tutoring, animal breeding, photography, etc.
  • An automobile executive retires and now is paid to consult for some of the vendors he worked with during his career.
  • A business executive is paid for serving on a board.
  • A direct sales business is entered into as a side income or because the individual simply loves the product. 

Like a traditional IRA, the self-employed SEP is deducted from your income on the front page of your personal return and can yield significant tax savings. In situations where self-employed income is not the primary source of an individual’s cash flow, a SEP can help keep a taxpayer from moving into a higher tax bracket and at the same time defer any taxes on the SEP contribution.
 
Let’s look at an example. An executive earns $400,000 per year in salary and has $50,000 per year of investment income. She also earns $150,000 per year serving on the board of a local bank, which is considered self-employment income. The total federal tax bill on this income is $185,500. If she makes the maximum SEP contribution of $29,598 ($150,000 of self-employment income less $2,009 of deduction of self-employment tax times 20%) the federal tax bill reduces to $173,779. So not only does she receive the benefit of $29,598 going into her retirement funds, but the tax savings of $11,721 helps pay for it!
 
If any of the situations above seem to apply, it’s worth a conversation with your accounting team to discuss the pros and cons of setting up a SEP. 
 
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.