Self-employed individuals may have questions about which retirement plan works best for them and their employees. Why not consider a SEP IRA?
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This story originally appeared on MarketBeat
I just took the leap to become a self-employed individual. Now "retired" from the corporate world, I knew all along that I'd have to switch out my 401(k) to an IRA. I no longer have the advantage of the employee match (doggone it!) and now my thoughts have turned to how to save for retirement on my own.
I might tap into a tax-advantaged retirement account called a Simplified Employee Pension plan, or SEP IRA. My research shows that SEP IRAs can offer a boon for self-employed people or small-business owners with few or no employees.
What's a SEP IRA and what do you need to know before you open this type of retirement account? Let's dig in.
The SEP IRA lets employers (individuals, sole proprietors, and small business owners) contribute to traditional IRAs set up for employees.
The SEP IRA offers a tax-advantaged retirement savings account — a great option for both employers and employees.
Half the challenge involves getting started, just like with anything. However, you can open a SEP IRA just about as easily as buying a single stock. Let's make it super simple and distill it into just three steps:
How do Traditional IRAs and 401(k)s differ from a SEP IRA? It functions very much the same. The only really huge difference involves the fact that a SEP IRA benefits self-employed people or small business owners.
A SEP IRA grows tax-deferred until retirement. This means that when you take money out of the account when you retire, your money gets taxed as income. You can begin to make withdrawals from your SEP IRA account when at 59 ½.
What happens if you decide you need your money before age 59 ½? You may have to pay a 10% early withdrawal penalty fee. However, as with most things, you can find exceptions to the rule. If you plan to buy your first home or pay for certain college expenses, you can use SEP IRA money to pay for those things.
As you add money, take note of the limits. You can rack up to $58,000 in your SEP IRA in 2021. However, annual contribution limits cannot exceed 25% of compensation or $58,000 in 2021 — whichever is less.
The biggest advantage of a SEP IRA involves its high contribution limits — if you can swing it, $58,000 annually can make a huge impact on your retirement portfolio. Other major advantages include its other winning features:
Make sure you know the disadvantages of a SEP IRA before you choose a SEP for your employees and yourself.
Employee eligibility requirements: For those who have employees, you must contribute on your employees' behalf and employee contributions must equal your own contribution percentages. The short explanation: When you invest 10% of your own income into a SEP IRA, you’ll also contribute 10% into your employees' SEP IRAs as well.
Other eligibility requirements for employees: Employees must have passed their 21st birthday, worked for your business during three of the past five years, and earned at least $650 in the past year in 2021. Check out more requirements through the IRS.
Among those plans for the self-employed or small-business owners: an IRA (traditional or Roth), a Solo 401(k), a SEP IRA, a SIMPLE IRA or a defined benefit plan. One of the biggest benefits among several of those plans involves the opportunity to save way more than with
Which one works best for you? Carefully consider which type of retirement savings option meets your needs, your employees' needs and more. Finally, consider your age, current income and risk tolerance. Consult with a financial advisor if you're really not sure which one will benefit you the most.
As for me, I'm still deciding which type will work best for me — that is, beyond my Roth IRA.
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