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SEP IRA: Self-Employed Retirement Plans

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Are you self-employed and looking to retire someday? I am. Since this website brings in a little income, it qualifies as a small business. Additionally, I contract for some other companies, which also counts as small business income. The life of a contractor is often one without a 401k. Despite my Devil's Advocate post of throw away your 401k, having the option for automatic savings is great when you are as Lazy as I am. Well I'm not going to sit around crying about lacking a 401k plan. Instead it's time to alternatives. There are a few of them out there (and I expect to cover them in the coming weeks), but today I'd like to start with Self-Employed Retirement Plans: SEP IRA.

Before I start, I should give a few caveats. I'm not a tax-advisor. I'm not even a financial planner. This is just one person's opinion based on some research. If you have knowledge in this area and I'm off, please let me know. In the upcoming weeks, I'll talk with my tax advisor about what do for real. My theory is that it can't hurt to come in prepared. If I know the pros and cons of each plan, the meeting will go that much quicker.

SEP IRA: Self-Employed Retirement Plan Benefits and Basics

In looking at retirement programs, I found 5 areas that I should focus on:

  1. Contributions are tax-deductible - My tax rate this upcoming year with the full-time consulting looks to be fairly high. I can avoid that high rate now and take a chance that I'll have a lower rate at age 59 1/2 (or later). Usually that's a good bet since income and hence your tax rate typically drops in the retirement years (right?). Still it's something to consider that it might not be the case.
  2. Low administration costs - A little like keeping the expense ratio down on a mutual fund, low administration costs automatically save you money off the top.
  3. Choose your own investments - SEP IRAs are like other IRAs, so you can invest in the same way as you would anything else. For instance, I could get a brokerage account at Fidelity
  4. SEP IRA contribution limits - The contribution limit isn't as straight-forward as you might expect. According to Wikipedia the contribution the limit is 18.587045% of your net profit. That 18.580745% may sound like a crazy number, but it's actually derived from accounting FICA tax and other limits that are over my head. It seems like there's an top level maximum of $49,000 in 2009. This complexity is exactly why I have tax people to help. For me this 18.58% number is looking like it might be a good thing. I could potentially be able to squirrel away more tax-deferred money with the SEP IRA than I could with a 401K plan.
  5. SEP IRA contribution deadlines - The deadlines seem the same as other IRAs, so I should be able to simply wait until I have my taxes done in March next year and write a big check. However, in general, I probably want to be contributing a little every month and then just finish up with a bigger check to the limit as opposed to having request an IRS extension form and filling your taxes late.

Caveats of SEP IRA

SEP IRA's aren't all rainbows and puppy dogs... and it's certain not a pot of gold. Here are some of the things I'd have to think about before jumping in:

  • All employees must receive the same benefits - Since I'm the only employee this is an insignificant factor for me.
  • 18.587045% of net profit - I'm trying to invest back in my business with web sites so I've been thinking about intentionally keeping my profit low. However, my full-time consulting is essentially all profit, so that could be a significant amount.
  • SEP IRAs are not a free lunch - By going with a SEP IRA, I'd only be deferring paying taxes. It's not like I get out of paying tax altogether. Then again, when looking at retirement vehicles, nothing is a free lunch, so this is to be expected.
  • 10% early withdrawal penalty - If I try to access the money before age 59 1/2, I'll pay a 10% penalty on the money. Do I really want to lose access to this money for the next 26 years?

In the end, I'm thinking that a SEP IRA may be a strong contender as a place where I should put my money. The fact that it's relatively easy get up and going is a huge plus for someone as Lazy as I am.

Last updated on December 14, 2011.

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7 Responses to “SEP IRA: Self-Employed Retirement Plans”

  1. P.B. says:

    Reading through your article I see no mention of a Roth IRA option within a 401(k), which as a small business owner you are entitled to open. Maybe this is something you will be exploring in another article. This allows your after-tax contribution to grow and then pull it out tax free someday, because who knows, you might be making more money in your retirement days from you excellent blogging!

  2. Lazy Man says:

    Those are other alternatives that I’ll cover later. Covering SEP IRA is enough for one post.

  3. Lazy Man,

    I have one concern about the SEP-IRA versus a traditional IRA:

    Although you have no employees today, do you anticipate NEVER having employees? While the SEP-IRA gives you the ability to fund more than a traditional (or Roth) IRA, it also requires you to fund (with no vesting requirement) your employees.

    Also, you didn’t say if you’re an S, C or sole proprietor filing under Schedule C of your 1040 but the issue of net (also known as taxable) profit would come into play here. The goal of a small business usually is to get net profit as low as possible. You might end up paying more taxes on your profit to get a higher IRA funding limit.

    Looking forward to more information.


  4. Lazy Man says:

    Yes, I anticipate never having employees. I’m simply a sole proprietor now.

    I need to talk to my tax people, but I’m pretty sure that they are going to say SEP-IRA is the way to go.

  5. Jim Patton says:

    I work as a contractor and setup a SEP IRA. All my contributions are after tax. Can I still withdraw the after tax principle contirbutions without incurring a penalty?

  6. Lazy Man says:

    I don’t think you can Jim. There might be something where you can do it in the same year. I’d consult your tax advisor.

  7. MJames says:

    Can I use my ETrade account for my SEP IRA? I currently have a SEP IRA set up with my bank and managed by my broker. But I recently setup an Etrade account and have done very well with it. Can I take that amount and use it as my SEP IRA contribution this year? If so how to I go about that. To this point, each year (about 4 yers now) I’ve simply given the ok to my banker to remove the necessary funds from my business account and place them into my SEP IRA each that he manages. Would like to do a little managing of these funds on my own but not sure how to set it up. Any thoughts or where to go to get this info?

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