Introduction
For small business owners, planning for retirement is crucial but can be complex due to the variety of retirement plans available. In this blog post, we will look at the Simplified Employee Pension (SEP) IRA. Here, we’ll explore how this plan works for a Schedule C (Sch C) business owner versus an S Corp employee and owner, highlighting the benefits, limitations, and strategic considerations for each.
What is it?
- A SEP IRA allows an employer (including self-employed individuals) to make contributions toward their own and their employees’ retirement.
For Sch C Owners:
- Contributions: You can contribute up to 25% of your net earnings from self-employment, not exceeding $61,000 for 2024 (subject to annual adjustments). However, you calculate your contribution on your net income after subtracting the SEP contribution itself, which effectively means the limit is based on about 20% of your net earnings.
- Flexibility: One of the biggest advantages for Sch C owners is the flexibility in contributions. Each year you can decide whether to contribute, and how much, based on your business’s performance.
- Simplicity: No annual filings are required beyond the initial setup, making it a low-maintenance option.
- Employee Considerations: If you have employees, you must contribute an equal percentage of salary for each eligible employee, which could increase your costs if your business expands.
Challenges:
- The requirement to contribute for employees if you have them can be a drawback if your business has a fluctuating income.
For S Corp Owners:
- Contributions: Works similarly for Sch C owners, but because your compensation from the S Corp is treated as W-2 wages, the calculation for contributions is straightforward. You can contribute up to 25% of your W-2 income.
- Complexity: SEP are simpler and require less maintenance than 401(k) plans.
- Employee Benefits: If you have employees, they can also benefit from the plan, which can be an attractive incentive for talent retention.
Strategic Considerations:
- Tax Benefits: SEP IRAs offer S Corp tax deductions for contributions, reducing the taxable income on the 1120-S.
- Growth Potential: Retirement accounts grow tax-deferred, meaning you don’t pay taxes on earnings until withdrawal.
- Exit Strategy: If you’re planning to sell your business, having a robust retirement plan can enhance your company’s attractiveness to potential buyers.
Conclusion
A SEP IRA offers significant benefits for self-employed individuals and small business owners, including the ability to contribute a substantial amount towards retirement—up to 25% of net earnings, with a cap of $61,000 for 2024. It provides flexibility in contributions, allowing you to decide each year how much to contribute based on your business’s financial performance. Additionally, SEP IRAs are relatively simple to set up and maintain, with minimal administrative requirements compared to other retirement plans, making it an attractive option for those looking to streamline their retirement planning.