Twin Reaper: If you are self-employed, a SEP-IRA lets you save for retirement
By: Lee Michael Katz; Source: AARP Bulletin Today Date Posted: 2007-03
Ina Sheets, 56, works for herself as a massage therapist, but still funds a pension. It's called a SEP, short for Simplified Employee Pension. Like millions of Americans over 50, Sheets has self-employment income, so she's eligible to take advantage of a SEP-IRA to save money for the future—while enjoying tax breaks today. "It's like a savings account…with a tax deduction," notes Sheets, who lives in California. Her SEP-IRA, she says, has saved her "a considerable amount of money."
"I think it's probably an undiscovered gem compared to other kinds of solutions for retirement," says Charles Schwab and Co. spokesman Glen Mathison. "You can make pretty high contributions to a SEP."
IRAs were created by the government to help people save for retirement: Contributions grow tax-deferred (tax-free in a Roth IRA). Over the years the amount you're allowed to contribute has increased to $4,000 a year—and to $5,000 if you're over 50. A SEP-IRA operates the same, but the contribution limit is based on earnings. So, if you have substantial self-employment income from business, consulting, sales or even moonlighting, a SEP can trim your taxes and allow you to sock away a lot of money.
Pennsylvania tax attorney and professor Kenn Tacchino tells audiences in a middle income tax bracket that they can save 25 cents on every dollar in federal taxes while profiting from SEP investments, like savings accounts, mutual funds and stocks. "It's playing with house money," he says.
Procrastinators take heart: Just when you thought you were finished filing your taxes, here's a way to save: you have up until April 17—or even mid-October if you file an extension—to establish or fund a SEP for the previous tax year.
"We get a large increase of contributions in April and October from employees funding their plans," says Gregg Piehl of Ameriprise Financial. A 2004 AARP study found nearly one-third of self-employed older workers made that job transition after age 50. With "the boomer generation simply not retiring," notes Piehl, "our SEP business is definitely growing…To save for retirement and get a tax deduction at the same time, this works very well."
Here's how a SEP works:
Cost
Setting up a SEP is often done for a nominal charge or even free through financial planners, mutual fund companies, brokerage firms, banks and other financial institutions. Unless you have a complex or unique situation, a plan would typically charge an annual custodian fee, "certainly no more than $100 a year," says Glenn McKinney, a financial planner with offices in California and Florida. "There may also be trading or transaction fees." A small business with employees can offer SEP plans, but the owner generally has to contribute for all eligible employees.
Eligibility
You only need $500 worth of self-employment income to qualify for a SEP in 2007. But its hefty tax deduction "becomes more valuable as your income goes up," says IRA expert Ed Slott of Rockville Centre, N.Y. The allowable contribution is based on a percentage of net self-employment earnings under an IRS formula. The maximum contribution was increased to a whopping $45,000 in tax year 2007.
Set-up
Establishing a SEP for a solo business owner can be as easy as signing a brief form and designating a bank or investment account. You face no annual filing requirements or complex paperwork.
Contributions
You're free to decide when to contribute to a SEP-IRA, whether monthly or even skipping years, if you wish. Many self-employed individuals write a last-minute check to reduce a big tax burden. However, McKinney and other financial planners recommend regular contributions to maximize a SEP's growth and tax advantages.
No Age Limit
Unlike a traditional IRA, you can still contribute to a SEP after age 70½. This can help offset the tax bite of mandatory annual withdrawals after that age. Depending on your income and situation, other tax-advantaged retirement plans, from a Roth IRA to a solo 401(k), might also meet your needs. Check with your tax advisor.
preview