Tax Time: Retirement plan for Indies

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Tax Time here in the U S of A.   This post is for self-employeed and small business owners in the USA but does not constitute tax advice – you should consult a qualified licensed/certified tax professional – but is just some information to help you ask them some leading questions and pointers to documentation on the IRS.gov website for educational purposes.

π

As I’m calculating the basis in my SEP-IRA due to some conversions of IRA to ROTH IRA, I’m reminded that I lost out on about 10 years of pre-tax retirement savings due to a bad CPA who said I wasn’t eligible to do so since it was an S-Corp.  Got a new CPA and found out the first one was wrong (or the law changed and he was wrong at first but didn’t inform me that it had changed).

I suggest you educate yourself by starting at IRS.gov SEP FAQs and learn enough to ask the questions I should have :-/

The great thing about a SEP-IRA, for an S-Corp anyway (not sure about LLCs or sole-proprietors), is that the business makes the contributions for the employee and these contributions are deductible business expenses.

The limits are also a LOT higher than you as an individual have.  From an FAQ sub-page linked to from the one above:

How much can I contribute to my SEP?

The contributions you make to each employee’s SEP-IRA each year cannot exceed the lesser of:

  1. 25% of compensation, or
  2. $53,000 (for 2015 and 2016 and subject to annual cost-of-living adjustments for later years).

These limits apply to contributions you make for your employees to all defined contribution plans, which includes SEPs. Compensation up to $265,000 in 2015 and 2016 and subject to cost-of-living adjustments for later years) of an employee’s compensation may be considered. If you’re self-employed, use a special calculation to determine contributions for yourself.

So if you’re making more than $72,000 a year you can start to exceed the $18,000 personal contribution limit to a SEP-IRA or 401K.

This makes it sound like you don’t have to be a Corporation (but read Publication 560 & ask your CPA):

How much can I contribute if I’m self-employed?

The same limits on contributions made to employees’ SEP-IRAs also apply to contributions if you are self-employed. However, special rules apply when figuring the maximum deductible contribution. See Publication 560 for details on determining the contribution amount.

The only real down-side that I’m aware of (again, consult your hopefully better-than-my-old-CPA CPA) is that you make this contribution for all employees who meet the criterion you set in the SEP Plan Document.  The IRS has a “model SEP plan document”, form 5305-SEP that I used and that might be enough for you.  See the details/restrictions here.

My company mostly used contractors and I set the requirement to full-time employment for 3 years which was likely to exclude all but the most dedicated and valuable employees (and which I already qualified for :)).

On the other hand, having a good retirement plan that is competitive with with a big company’s 401K plan might help you attract employees that you otherwise couldn’t, so you might want eligibility that let’s employees participate as soon as they’ve passed some introductory trial period (90 or 180 days or whatever).  Notice that the limits for the SEP-IRA are actually higher than those for a 401K plan once compensation crosses the $72,000/year threshold.  So you can actually provide a more aggressive retirement plan with a SEP-IRA plan than with that big company 401K plan (unless I’m missing something).

And the employee can also make a ROTH IRA contribution as well (subject to the usual ROTH IRA contribution limits).

A SEP-IRA is cheaper to operate than a 401K plan (which is complicated enough that you have to pay a service to operate it for you – and they aren’t cheap).  Your employees can open their own SEP-IRA account and your business simply deposits money into it.  (See the IRS site for details).

Over the 10 years I was operating with the bad CPA I could have saved a lot more for retirement than the ~$4000-$5000 ROTH IRA limit, if only I’d known….   Now you know.

Go forth and save those pre-tax dollars for retirement!

Your 50-year-old self will thank you.  😀

 

This is not tax advice. All readers should consult a qualified tax professional about any tax decisions they make for themselves or their business.

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