SEP IRA for Self-Employment Revenue Fundamentals (2020 & 2021)

I lately did some in-depth analysis on SEP IRAs, SIMPLE IRAs, and Solo 401Ks for private use for my aspect self-employment earnings and needed to cowl the first questions I had and solutions I discovered, in your profit (and to assist myself keep in mind, if I’m being completely trustworthy).

In case you have self-employment earnings (or plan/hope to sooner or later), or any aspect venture or aspect hustle earnings, this must be of curiosity. If you wish to work for “the person” for the remainder of your days, you’ll be able to most likely tune out.

This submit, an summary of SEP IRA fundamentals, might be half 1 of a multi-part sequence. I’ll wrap it up with a comparability between retirement plans for self-employment earnings.


What’s a SEP IRA?

SEP doesn’t stand for “self-employed plan” or “self-employment plan” as one may count on. Actually, it stands for “Simplified Worker Pension”. The cool youngsters (are monetary professionals “cool”?) pronounce it as one phrase – “sep”, versus “S-E-P”, the best way.

If you’re wanting right into a SEP IRA for the needs of directing self-employment earnings to retirement financial savings – don’t let the “worker” within the title deter you. Enterprise homeowners can create a SEP IRA providing for workers (I gained’t cowl the particulars on this submit, so that you’ll wish to seek the advice of different assets), however you can too create one for your self.

At its core, SEP IRAs are very just like Conventional IRAs. Each are pre-tax funding autos that permit you to deduct contributions out of your taxable earnings to avoid wasting for retirement.

The primary distinction between the 2 is who can contribute and the way a lot you’ll be able to contribute.

What are the {Qualifications} to Create & Contribute to a SEP IRA?

In case you have self-employment earnings, you’ll be able to set up and contribute to a SEP IRA with a couple of {qualifications}:

  • Have to be age 21 or older

  • Will need to have labored for the employer (your self) in at the least Three of the final 5 years

  • Will need to have acquired at the least $600 (2020) or $650 (2021) in compensation from the employer (self-employment earnings)

Self-employment earnings for the aim of this deduction means web income from a Schedule C or Schedule F, self-employed earnings from a partnership, or wages as a shareholder-employee in an S-corporation. You do not need to have a registered LLC or keep different integrated standing to be eligible for a SEP.

Are you able to Contribute to Each a 401Ok and a SEP IRA?

In case you have an employer, you’ll be able to contribute to each your employer’s 401Ok and make a contribution to your individual SEP IRA (as your individual employer) concurrently. Fairly candy.

Can SEP IRAs be Roth SEP IRAs?

No. At the moment, SEP IRAs are solely pre-tax in nature and “Roth SEP IRAs” don’t exist. Given the current reputation of Roths and the addition of Roth IRA and Roth 401Ok accounts as funding autos in recent times, I’d speculate that may change. However right now, pre-tax solely.

Are you able to Roll SEP IRAs Right into a Roth IRA?

Sure, you’ll be able to roll a SEP IRA in to a Roth IRA, if you happen to’d like. Remember, as with all traditional-to-Roth rollovers, that any quantity you roll over is taken into account taxable earnings within the 12 months that you just roll it over.

SEP IRA Contribution Deadlines

SEP IRAs have the identical IRA contribution deadline as Conventional and Roth IRAs and the tax deadline for that calendar 12 months (sometimes April 15). Extensions are potential.

And as with these IRAs, if a contribution comes between January 1st and the tax deadline, you’ll be able to characterize it for the earlier or the current calendar 12 months. This (very conveniently) lets you decrease your tax legal responsibility for the prior calendar 12 months on the time you might be really doing all of your taxes. Observe that contributions for a calendar 12 months have to be made previous to submitting your taxes for that 12 months.

SEP IRA Contribution Limits

To recap, the most IRA contributions for Conventional and Roth IRAs are capped at $6,000 in 2020 & 2021 (with a catch-up contribution of a further $1,000 in case you are age 50 and above). There are additionally earnings phaseout restrictions for every, at which level your capacity to contribute (or deduct your contribution) is phased out to $0.

That is the place SEP IRAs deviate considerably from Conventional and Roth IRAs and might be vastly superior, if in case you have self-employment earnings.

The most SEP IRA contribution for every worker can go as much as the lesser of:

  1. 25% of compensation, or
  2. $57,000 for 2020, $58,000 for 2021

Nonetheless, particular guidelines apply for self-employed people which limits the utmost deductible contribution that they’ll make.

Must you Contribute to a SEP IRA as an Employer or an Particular person?

If you make a SEP IRA contribution, you could have the choice of contributing to a SEP IRA as an employer or particular person. In case you have self-employment earnings, you’ll be able to contribute as your individual “employer” and will do this first. You might additionally contribute as an “particular person”, however you’ll wish to be sure you keep below the Conventional IRA earnings limits for eligible tax deductions.

Calculating the Self-Employed Most Deductible SEP IRA Contribution:

The calculation for the way a lot you’ll be able to contribute to your individual SEP IRA as an “employer” isn’t as straightforward as taking the proportion (as much as a max of 25%) and multiplying your web earnings. Why? As a result of your SEP contribution should first be deducted out of your web earnings.

To determine how a lot you’ll be able to deduct:

  1. Begin together with your web revenue (earnings minus bills)
  2. Subtract one-half of your self-employment tax (which is a deduction)
  3. Subtract your SEP contribution (additionally a deduction)

Wait, how are you going to calculate the SEP contribution if you happen to don’t but know the proportion charge you’ll be able to contribute?

That is the place the IRS SEP charge desk for self-employed contributions can assist. To calculate the speed your self, right here is an instance, assuming a plan contribution charge of 25%:

  1. Put your plan contribution charge (as a decimal): 0.25
  2. Add 1: 1 + plan contribution charge (on this instance, 0.25) = 1.25
  3. Take #1 and divide #2: (0.25/1.25) = 0.2

To get the max deductible contribution, multiply the end in step #3 (the identical as the chances within the charge desk) your web self-employment earnings, earlier than SEP deduction.

For instance, the max deductible contribution for $100,000 would equate to $100,000 x 0.2 = $20,000. This equates to 25% of the post-deduction earnings of $80,000.

Go forward and re-read that a couple of occasions, if you happen to’d like. 😉

SEP IRA Contribution Calculators

If you wish to double-check your math, listed here are a couple of SEP IRA contribution calculators that may help:

The place Are you able to Open a SEP IRA?

SEP IRAs are pretty common and every of the low cost brokers highlighted in my “the way to begin a web-based dealer account” article have a SEP IRA choice. Ensure to analysis minimal stability necessities and any related charges, together with account upkeep or inactivity charges earlier than creating your account.

SEP plans are extremely straightforward to arrange and require no extra paperwork or submitting necessities than different IRAs.

SEP IRA Assets:

In case you have any questions, positively seek the advice of with a tax skilled and/or a brokerage agency.

Exterior of the SEP IRA assets highlighted earlier, you also needs to try the next IRS articles on the subject:

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