What is SEP IRA?
A Simplified Employee Pension, Individual Retirement Account provides business owners a vehicle to contribute towards their own as well as their employees’ retirement. Each individual needs to set their own IRA account and it will be managed independently. The contributions are made pre tax and the taxes are taken at the distribution time. All earnings and capital gains grow tax free. The contributions made to the plan by the business owner as well as the employees’ contributions matched by the organization can be deducted from the income. The organization can claim a tax credit for the necessary costs to set up the SEP. This credit equals 50% of the cost to set up and administer the plan and educate employees about the plan, up to a maximum of $500 per year for each of the first 3 years of the plan.
How does the SEP IRA fit in the GET RICH FRAMEWORK?
For the purpose of our discussion, we shall be looking at the SEP IRA in terms of a sole proprietor running the company. This is mainly because we are supplementing our full time income with side hustles and thus we want to shelter as much income as possible from getting realized and in turn reducing the tax burden.
The SEP IRA is an excellent way to save money for retirement. A general rule of thumb is that you would need 2.5 to 4 times your annual salary stashed away for use during your golden years. Then if you withdraw 4% every year, adjusted for inflation and a return of 6 to 7%, your money will outlast you.
The main advantage of the SEP IRA is the size of the contributions. For the year 2019, it is $56,000 or 25% of the revenue, whichever is greater. In a side hustle, it is difficult to predict the income any given year, so the flexibility is available to make contributions year-to-year. The online discount brokers offer these accounts and take care of most of the paperwork. The IRS two-page form 5305-SEP could be used as well. The start-up and operating costs are low.
The deadline for setting up an SEP can be as late as the due date (including extensions) of the business’s income tax return for that year. The contributions made are immediately vested and can be invested in individual stocks, mutual funds, and other, similar types of investments. The monthly and annual statements will be available from the associated brokerage account.
The contributions and earnings could be rolled over to other IRAs and retirement plans.
Withdrawals
The SEP contributions and earnings can be withdrawn any time. However, if the withdrawal is made before the age of 59 1/2, a 10% additional tax applies in addition to the regular tax rate. After the age threshold, the tax rate is whatever the individual’s income tax rate is at that point. The assumption is that during that age, the income would usually be lower. The money would grow tax free and withdrawals can be done at a lower rate. If no withdrawals are made until age 70 1/2, the minimum withdrawals kick in.