Preface: SEP-IRA’s permit up to $53,000 dollars to be tax deferred for 2015. In plain English, as a + savings strategy, what are the highlights and drawbacks?

 

Can a SEP-IRA Reduce Your Tax Bill

Self-employed and looking for ways to reduce or defer your tax bill? A Simplified Employee Pension Individual Retirement Arrangement (SEP-IRA) may be an option for you. SEP-IRA’s are congruent with profit-sharing plans. Employers can contribute up to 25% of wages to a SEP-IRA (20% for self-employed individuals before self-employed tax deductions) with a limit of $53,000 for 2015. Employers may contribute up to 25% of an employee’s wages to the SEP-IRA too. For instance if an employee earns $50,000, the employer may make a profit-sharing contribution up to $12,500.

SEP-IRA’s work for sole proprietors, partnerships, and corporations. For instance if you’re an independent contractor and want to make retirement contributions with flexibility on the contribution intervals, and low administrative costs, a SEP-IRA probably will suit that retirement plan criteria; and include simplicity of set-up with typically inexpensive ongoing administrative fees compared to a 401k.

SEP-IRA’s can be set-up at the last minute, so if you need to reduce taxes after tax year end, a SEP-IRA has that flexibility. You can create a SEP-IRA for your business up until the due of the employers income tax return, including extensions. Don’t wait until the last minute if you have proper tax planning, but it’s an option.

For employees, once an employer makes a contribution, the money is in your mine. Whereas a 401k usually has a vesting schedule. Employers are not required to file the Form 5500 with a SEP-IRA that is required for a 401k. If you’ve ever filed a 5500, you realize time saved is money saved. Another drawback? Loans are not available from a SEP-IRA either.

Contributions to SEP-IRA’s are not required every year and are made by the employer only. Part-time employees who are 21 year of age or older, have worked for three of past five years for the business and earn $500 must be covered by the plan.

So why may a SEP-IRA not be the optimal tax deferral strategy for your business. Well, let’s say you have an S-Corporation and pay yourself a $100,000 salary. You contribute $25,000 or 25% of your salary to the SEP-IRA plan for the year. If you have two employees who each earn $50,000 salaries in addition, you would be required to equally contribute the same percentage (25%) for your employees too; this would be an additional $25,000 expense. Highlight: your tax bill will be lower; that’s what profit sharing is.

Maybe you say you think a SEP-IRA may still be of interest to you. First, talk with your tax advisor, CPA, or a financial group that can serve as trustee of your SEP-IRA, and determine what you really need to consider before writing the check(s). Investment advisors can sometimes serve as advisors on SEP-IRA’s with trustee accounts through their organizations secured brokerage firm. You need a knowledgeable advisor to oversee the SEP-IRA to avoid making expensive mistakes; mistakes such as failing to update the plan documents, excluding eligible employees from participating, contributions that are wrongly calculated or not uniform, or contributions that exceed the maximum level or allowed contributions.

The pace to set-up a SEP-IRA is to first obtain a written agreement with benefits outlined to all employees, then you need give information about the agreement to all employees, followed with the ultimate set-up of an IRA account for each employee with the trustee.

Summary: SEP-IRA’s are a flexible tax deferral strategy. If you have a business with a profit-sharing plans, a SEP-IRA might work for you.