IRAs for the Self-Employed

If you’re on your own when making a living, one of your biggest worries must be funding retirement. Think that, because you have no workplace 401(k) and no employer matches for your investments, that you also have no hope of living well in your golden years? Think again: a specialized individual retirement account can help.

One unique variety of retirement accounts is the simplified employee pension IRA, or SEP IRA. This plan is designed for self-employed folks as well as for small businesses of any tax organization, whether a corporation, sole proprietorship, limited liability company (LLC), limited liability partnership (LLP) or any other kind of partnership.

The primary benefit of this plan is its simplicity (as the name implies) and the small amount of expense or paperwork involved in setup and administration. The SEP becomes less beneficial, though, when you add employees; you may find options available in other types of plans, such as a 401(k), more desirable if you own a business with more employees.

SEP IRAs operate under a completely different set of contribution limits from the other kinds of IRAs and retirement plans. For example, in 2015, you can contribute up to $53,000 to a SEP IRA, more than twice a 401(k)’s ceiling. That amount maxes out at 20% of your net self-employment income or 25% of wage income if you are an employee of the business.

Note: Elective deferrals, under which you agree to contribute directly to your IRA with a portion of each of your paychecks, and catch-up contributions of additional money if you’re older than a certain age are not permitted in SEP plans.

Just like in any other IRA, you can invest in any valid investment security that the custodian offers, roll over the plan upon termination of employment and bequeath the assets of the plan to your heirs however you wish.

Money you contribute to the plan is excluded from the income of you, the employee/participant, and you pay no taxes on any growth in the account until you take distributions (make withdrawals) in retirement.

When you turn age 59½, you can access the funds without penalty. Otherwise, you pay a 10% penalty in addition to the income tax on the distribution unless you meet one of the early distribution exceptions, such as:

  • qualified education or high unreimbursed medical expenses;
  • disability;
  • natural disaster;
  • divorce;
  • limited medical insurance premiums if you lose your job; and,
  • some first-time home purchases.

These are just a few of the possible situations permitting early and penalty-free withdrawals, among others. All are subject to specific conditions.

At age 70½, you must begin taking minimum distributions from the account, just like with any other IRA.

Additionally, you can establish a SEP IRA up to the tax-filing date for your business entity, as late as the April filing day of the following year (right now that’s April 18, 2016). This differs from a 401(k), for example, which must be established during the tax year.

Annual obligations aside, a SEP can be your perfect answer if you’re self-employed – and your perfect tool for peace of mind about the years ahead.

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Jim Blankenship, CFP, EA, is an independent, fee-only financial planner at Blankenship Financial Planning in New Berlin, Ill. He is the author of An IRA Owner’s Manual and A Social Security Owner’s Manual. His blog is Getting Your Financial Ducks In A Row, where he writes regularly about taxes, retirement savings and Social Security.

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