For freelancers or small-business owners, a SEP IRA is an easy choice. It stands for simplified employee pension, and a SEP is really simple, to open and to use for any self-employed income you make before retirement. The contribution limits beat other retirement plans. You can contribute (or not) when you want. And you have until you file your taxes on April 15, 2013 (or October 15, 2013 if you file an extension) to make a 2012 SEP IRA contribution. If you don't have a SEP IRA yet, you can still open one for 2012 using the same deadlines.
A SEP IRA is very similar to a traditional IRA or other type of tax-deferred retirement investment account. You put in a portion of your self-employed income in and that money can be deducted from your taxes. SEP IRA contributions are, in general, 100% tax-deductible. You invest the money that's contributed to the account, and delay taxes until retirement between age 59 1/2 and age 70 1/2. If you take money out before then, you will generally have to pay a 10% penalty, plus any applicable federal, state and local income taxes.
2012 SEP IRA Contribution Limits
If you are looking for higher contribution limits, a SEP IRA is a great choice in any year. Participants can contribute as much as 25% of gross annual salary or 20% of net adjusted annual self-employment income. In 2012, those contribution amounts must not exceed $50,000. That's a potential $50,000 contribution maximum, compared to the 2012 401(k) limits of $17,000 (those who qualify for a catch-up contribution may be able to go as high as $22,000).
If you are a highly compensated self-employed professional, such as a dentist or attorney, a SEP IRA can help you reduce your income and save more. Even if you are employed full-time and participate in a 401(k) or 403(b), if you have any self-employment income, you can contribute to a SEP.
Calculating Your SEP IRA Contribution
Another cool thing about the SEP is that there is no required contribution each year. You can contribute one year and not the next, or the next dozen. You also don't need to itemize your taxes to take a SEP IRA deduction (it's known as an above the line deduction). But there is a trick to calculating an accurate contribution amount. Take your gross (or total) income, subtract any business expenses, then subtract half of the self-employment tax. But your SEP IRA contribution must be included in those business expenses. You can try and find a contribution calculator to help you with this, or even a trustworthy tax software program, but a tax accountant or advisor will provide better help with these types of calculations.
SEP IRA Contributions for Employees
If you are a business owner with more than one employee, SEPs get a bit less flexible. Employers must contribute to a SEP IRA the same income percentage for every employee. So if I, the business owner, want to contribute 25% of my income to a SEP, I must also contribute 25% of each of my employees' salaries to a SEP as well. More specifically, employees are eligible if they are 21 or older, earned more than $550 in 2012, and have worked for the company for at least three of the past five years.(There may be some exceptions for union employees. Check with your plan administrator for specifics about your plan.)
A SEP IRA is only one of retirement savings options available to small and solo businesses. It has some clear advantages, but it really depends on your business. If you have self-employment income from freelance or seasonal work and would like to stash some or all of it into savings, a SEP IRA is an easy and flexible option. If you have employees, a SEP is more complicated. Find out more about which self-employed retirement savings option could work for you.
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