Why You Should Have a New Best Friend Named SEP

Everybody likes to have friends. We all need to have someone who is going to take care of us if we fall on hard times. We need someone who will repay our kindness toward them when the going get rough. Let me tell you about someone who will be a great friend to have around when you grow too old to care for yourself. His name is SEP.

simplified employee pension SEP

SEP is actually his initials. It stands for Simplified Employee Pension. It is a retirement savings plan that will grow to take care of you when your working days are done, but it can also provide tax benefits here and now.

SEPs are especially designed for the entrepreneurs and small business owners. They work great for sole proprietors, LLCs, and S-Corps. As a small business owner, you can contribute up to 25% of your net income into the plan to reduce your tax liability. 

Here’s an example. If your business made… we’ll say, $100,000 even, just to keep the math simple. You could contribute up to $25,000 to your SEP. If you were taxed at a rate of 25%, a full contribution of $25,000 to your SEP plan would reduce your tax liability by $6,250. Now that’s a good friend! SEP will put that money back into your pocket that Uncle Sam is trying to take out. It’s as if that $25,000 invested into retirement savings only cost you $18,750. 

Not only will SEP reduce your taxes, you will have $25,000 invested for the future. In your twilight years, SEP will be there with you, making you comfortable while you’re sitting on the beach sipping a glass of wine. That’s a win-win proposition for you.

The $25,000 you contribute to your SEP would be treated like any other cash withdrawal on the business equity in your accounting software, except this cash withdrawal is completely deductible from your net income.

The advantage of the SEP over other traditional retirement plans like 401K’s, Roth, and traditional IRA’s is that the SEP has no minimum contribution. Some plans have a minimum initial contribution of a thousand dollars or more. You can start a SEP plan with as little as $1.00, and can contribute varying amounts each week. However, our suggestion is that you build a regular saving habit by determining an amount that you will contribute monthly and be disciplined to stick to that.

It could be a problem if you over contribute to your plan. To avoid this, ensure that you are checking your profits and losses monthly and your contribution is less than 25% of your net.

Why not start making friends with SEP today? When you complete your taxes and before you submit them, ask your accountant about a SEP contribution to reduce your tax liability. You can still contribute to your SEP or other retirement plans before your taxes are filed.

Your banker or financial planner should be able to help you set up a SEP quickly. It is not a difficult process. However, you should be aware of some issues if you have employees. Under the tax code rules for a SEP, you will be required to make the same contribution for your employees percentage wise as you do for yourself. So, if you contribute five percent, $5000 of your $100,000 net income to your SEP account, you will have to contribute $1250.00 to the SEP of your employee to whom you pay $25,000. And all employee contributions have to be made by December 31st of the tax year.

This is not necessarily a bad thing. The employee who helped your business make that $100,000 net income should be justly compensated for his work. Contributing to his SEP retirement plan would be a nice benefit for him or her.

The Bottom Line

Without a minimum set-up cost and big tax advantages, a SEP is a smart way to manage your tax liability and start saving for that inevitable day of retirement, should you be fortunate to live that long.

Your Turn

Have you ever considered setting up a SEP account?