If you earn income from being self-employed, you are eligible to start a Simplified Employee Pension (SEP) plan. A SEP plan is a business-sponsored retirement plan that allows you to deduct your plan contributions and put your savings to work earning tax-deferred investment income in your self-directed IRA.
It’s not too late to start a SEP plan and benefit from a tax deduction on your 2019 tax return. You have until your business’s tax-filing deadline, plus extensions, to establish and fund a SEP plan for a tax year. Here’s how it works:
1. Determine if you are eligible to contribute to a SEP plan.
Any type of business can establish and contribute to a SEP plan (e.g., sole proprietor, partnership, corporation). All you need is net earnings from self-employment in which you perform personal services to the business. This figure takes into account your gross income from your trade or business minus the allowable deductions, which include the deductible part of your self-employment tax and the deduction for your contribution to your SEP plan.
When you’re thinking about your contribution, be aware that if your business has employees and you choose to make a SEP plan contribution for the year, you must make contributions for all employees who meet the eligibility requirements you choose for your plan. These contributions are tax-deductible for your business, but they may affect how much you choose to contribute as your own SEP contribution.
2. Choose an IRA custodian.
A SEP plan is funded by making deposits to a Traditional IRA (sometimes called a SEP IRA). You will want to choose an IRA custodian that handles the types of investments you want to hold in your self-directed IRA. (Access STRATA Trust’s Instructions for Opening a Self-Directed IRA here.)
If you have employees, they will also need to choose an IRA custodian to receive the SEP plan contributions.
3. Choose a SEP plan document and establish the plan.
As the business owner establishing the SEP plan, you must complete and sign a plan document to establish a SEP plan. Most SEP plans are established using an IRS model document, called Form 5305-SEP. You should be able to obtain this plan document from your IRA custodian. (Access STRATA Trust’s SEP plan documents here.)
If you use the model document to establish your SEP plan, you must operate the plan on a calendar-year basis. If you have employees, contributions must be the same percentage of compensation for every employee (including yourself). You cannot maintain another qualified plan, have leased employees, or be a member of a controlled group where some members do not want to participate in the SEP.
As you’re completing the SEP plan documents, you can choose the eligibility requirements that your employees, if any, must meet to be eligible to receive contributions. Possible options include reaching a certain age (up to 21), working for you in at least three of the last five years, and earning at least $600 per year.
4. Decide how much to contribute.
Under a SEP plan, you could contribute up to 25% of your compensation or $56,000 for 2019, whichever amount is less. The maximum contribution increases to $57,000 for 2020. With contribution limits this large, a SEP plan can be an effective way to reduce your tax liability, build your self-directed IRA balance and invest in alternative assets. If you make a large contribution in one year, you are not locked into contributing that amount every year. You’re not required to even contribute to the plan each year, and when you choose to contribute, you can vary the amount from year to year.
Calculating your maximum SEP contribution and deduction is complex. Many self-employed individuals seek professional tax advice when making this calculation and calculating any contributions for employees. You can find more information and a worksheet in IRS Publication 560, Retirement Plans for Small Businesses.
5. Notify any employees that you have established a SEP plan.
If you have any employees, you must notify them when you establish a SEP plan, and provide them with information about the plan. If you used Form 5305-SEP to establish the plan, you may provide a copy of the form and its instructions to satisfy this requirement.
You must also notify your employees when you make a contribution to the plan. You must provide this notice by the later of January 31 of the year following the year for which the contribution is made or 30 days after the contribution is made.
Contact STRATA Trust for assistance.
It’s not too late to fund a SEP plan for 2019. Talk to your financial advisor or tax professional to make sure you understand the contribution potential based on your business income. You may also contact us at [email protected] with questions about funding a self-directed IRA through a SEP plan.