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I'm self-employed and my taxes are killing me!

| January 25, 2019
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The good news is you made a lot of money last year, the bad news is that Uncle Sam is now knocking on your door.  When a person is self-employed with no employees a SEP IRA is going to normally provide the most advantages with tax savings at the top of the list.  However, the moment you have even one employee the waters become murky since contributions for employees can be higher than expected.  You have any questions?

What is a SEP IRA?  It stands for Simplified Employee Pension, and it is a simple, tax-deferred retirement plan for anyone who is self-employed, owns a business, employs others, or earns freelance income. 

Why have a SEP IRA? If I had to give you two reasons I would say that it is a great way to reduce your taxable income since contributions are deductible, and that it’s high contribution limits allow you to really ramp up retirement savings during high earning years.

You mentioned something about taxes?  Sure did!  Our tax system is built on a progressive scale, meaning you get taxed at a higher rate for each additional dollar you make.  This means that the income from the last $50,000 that you made of your $350,000 annual income for the year was taxed much higher than that first $50,000 that you made.  So if you contribute $50,000 to your SEP-IRA then you will be able to deduct that highly taxed $50,000 from the top of your income for the year.  *As a disclaimer, you should reach out to a tax professional to understand the true tax savings you can receive from your contributions.

How much can I contribute?

  • You may contribute up to 25% of the employee's total compensation or a maximum of $55,000 for the 2018 tax year and $56,000 for the 2019 tax year, whichever is less.
  • Contributions are deductible. Hooray!
  • Contributions are not required every year, unlike other plans, which provides a lot more flexibility during years with lower cash flows.
  • Contributions are based on a percentage of income, and that percentage must be the same for all employees.

What are the pros and cons?  I’m so glad you asked!

The Pros

  • Tax-deductible contributions of up to $56,000 for 2019
  • Tax-deferred growth
  • No special filing requirement for employer
  • Flexible contributions to all eligible employees

The Cons

  • Only for self-employed individuals.
  • Employer contributions only, and must be equal as a percentage of income for all employees.
  • Can be costly when you have multiple employees.
  • As with all qualified retirement plans you cannot access your contributions before you reach age 59.5 without incurring penalties. It is not advised to ever take funds out before 59.5 years old.  

I hope this helped clarify a few things, and as always please reach out with any questions. 

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