Business owners – just like most taxpayers – are constantly on the hunt for ways to reduce their tax bills. I know, because my tax clients ask about it regularly. Another topic that my tax clients ask me about is saving for retirement. Then I get to tell them the good news – they can save taxes and save for their future retirement at the same time!
When you work for someone else, your employer may offer a retirement plan where you can contribute and reduce your taxable income. When you work for yourself, you can do the same thing. There are several retirement plan types where you (and your eligible employees, if you have any) can contribute on a pre-tax basis. If you want to explore all of the options, knock yourself out at this IRS website – https://www.irs.gov/retirement-plans.
One popular option selected by many small business owners is a retirement plan called a “Simplified Employee Pension Individual Retirement Arrangement,” commonly called a SEP IRA. Here are three reasons why:
- Easy and Flexible
A SEP IRA is easy to set-up with your bank, your investment advisor or a mutual fund. Set it up and make your contributions by the tax return due date, including extensions. Annual contributions amounts are flexible, which is good if your business cash flow varies from year-to-year.
- Generous Contribution Limits
A SEP IRA allows you an annual contribution of up to 25 percent of net business profits, after netting out the deductible half of self-employment taxes. That calculation is a little tricky, so you’ll need some help to get it right. There is an annual dollar limit, too. For 2020, it’s up to $57,000. Contributions must be made for eligible employees.
- No Costs
A SEP IRA has no start-up or operating costs that can be required for a conventional retirement plan. However, any investments selected to fund the account may have a management or investment advisory fee. It’s important to get a clear understanding of any fees or charges that will defray your retirement funds.
Other costs need to be considered when deciding if a SEP IRA is for you, like taxes and early withdrawal penalties. Distributions from a SEP IRA works just like a traditional IRA – any funds taken out before age 59½ are subject to a 10% early withdrawal penalty. That’s on top of the federal and state income tax.
Small business owners on the hunt for ways to reduce their tax bills can save on taxes and for future retirement by setting up and funding a SEP IRA. Saving for today and tomorrow at the same time could be the best news that you get all year.