UPDATED FOR 2019
If you’re self-employed, have no employees, and are looking for a place to stash a lot of retirement cash without a lot of hassle, look no further than the SEP-IRA. This amped up retirement savings plan works well for freelancers and side-giggers. (If you have employees, it’s still a good plan, just a little more involved. Find out more here.)
The Simplified Employee Pension (SEP) is super easy to set up and administer, with truly minimal paperwork. In fact, the form to establish a SEP is just one page. And you never have to file any plan paperwork with the IRS.
They’re also very flexible. For one thing, once you decide to set up a SEP, you have until your tax return due date – including extensions – to create and fund the plan.
Plus, contributions can change every year based on the current financial situation. In down years, you can skip the contribution. When money’s pouring in, you can put up to 25% of your net self-employment earnings… up to $56,000 for tax year 2019… into your SEP – almost ten times more than you could put into a regular IRA.
The slightly tricky part: Your allowable contribution involves a little math (we’ll cover that in a minute), a two-minute calculation that takes self-employment taxes and the contribution itself into account.
But before we get to that, you have to set up your SEP.
4 Simple Steps
SEPs are so easy to deal with that you can have one set up and funded in just 4 simple steps.
Step 1: Establish your plan with IRS Form 5305
Step 2: Open a SEP-IRA account through your financial institution (bank, brokerage, mutual fund company).
Step 3: Calculate your contribution
You need three numbers to calculate your SEP contribution:
- Your net income from Schedule C
- Half of your self-employment tax (SE tax)
- The reduced plan contribution rate (to account for the contribution), which you can find here or calculate yourself.
Here’s how to do the math. For the example, we’ll use net income of $50,000 and a contribution rate of 20%.
|Net income from Schedule C||$50,000|
|Half of the SE tax||($50,000 x 15.3%)/2||$3,825|
|Net income reduced by 1/2 SE tax||$50,000 – $3,825||$46,175|
|Reduced plan contribution rate||BELOW||16.6667%|
|The contribution||$46,175 x 16.6667%||$7.696|
2 steps to calculate your reduced plan contribution rate
- Start with your contribution rate (the percent of net income you want to contribute.
- Divide your contribution rate by 100% PLUS the contribution rate
Here’s how it would work if you wanted to contribute 20% of your net income.
20% / (100% + 20%) = 20% / 120% = 16.6667%
- Fund your SEP-IRA account with your calculated contribution.
That’s it – you’re done – and well on your way to a hefty retirement nest egg.