Hey, What Is A SEP IRA ... And Do I Need One?

Hey Pete and Damian! I'm hoping you can answer a savings question for me....

My wife is the primary breadwinner for our household. Besides taking care of things in and around the home, shopping, and transporting our daughter for school, I have a small home based business — I sell bonsai trees and supplies. From a few farmers markets a week, shows, and supplies I sell online, I probably only show a profit of about $12K a year.

My wife has a retirement plan from work and I have savings in a rollover from my old job.

We both contribute the max we are allowed into our personal IRAs each year. Now, in her case, she has her employer 401K and her IRA, and contributes the max into both. We also contribute the max allowed into my IRA. Now, since I own a small business, we are wondering if I can use my small business to help save additional money for us. I don't file a W2. My tax provider files a small business profit and loss statement (Schedule C) and a Self Employment tax statement (Schedule SE) when we file our income taxes.

Now with that background information, here is my real question: Can I (as a small business owner) open a SEP IRA account and contribute additional money in a SEP IRA, in addition to to max I can contribute into my personal IRA account?

Thanks in advance for your thoughts, S.Y.

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Hey S.Y, I’ve got good news and potentially better news for you.

SEP IRAs are fantastic tools for small businesses owners that allow them to save potentially LARGE amounts of money for retirement. In fact, for 2021, plan contributions can be as high as $58,000! There are a few things to be aware of, however...

First, SEP IRA contributions are made by the employer, not the employee. This isn’t a big deal for you since you don’t have employees, but could be for someone reading this response. The employee has no ability to contribute to this type of plan.

Second, the contribution amount can vary from year to year. If you’re an employer with a number of employees, this could be very welcome, especially if you experience a down year. Not being tied to a required contribution can free up cash flow, if/when needed.

The last thing I want to point out, and I think this is the bit that might trip you up, is the contribution amount you are allowed to make. “But, just a few paragraphs ago you said it was up to $58,000. That’s way more than I intend on doing.” No, I said it could be as high as $58,000. The SEP IRA rules say that the contribution cannot exceed the aforementioned $58,000 or a maximum of 25% of compensation, whichever is less. So, in your case your income falls under $232,000 it will be subject to the 25% of compensation limit. In other words, you’re looking at a max contribution of around $3,000 per year. In my opinion, I’m not sure that’s a good fit for what you’d like to accomplish.

The good news is, you have a simple option. SIMPLE IRA plans will give you a higher useable contribution limit ($13,500 for 2021 plus an over 50 catch-up of $3,000) and are simple to administer. You will be required to make an employer contribution (either elective or non-elective), but this is of little concern since you’re the owner and have no employees. Your contribution and the “employer” contribution all comes out of the same pot.

As always, check with your CPA or tax advisor to see which option makes the most sense for you and how these types of retirement plans align with your goals.