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.
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.
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:
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.