You don’t have to work for a big corporation to enjoy the same type of tax benefits that many corporate employees experience with their company retirement plans. If you’re self-employed, you can open a Simplified Employee Pension Plan (SEP) that may allow you to contribute thousands of dollars each year to a tax-deferred account.
SEPs are similar to 401(k) and other corporate retirement plans in that both are funded with money you make before taxes, or pre-tax contributions. Investments within both plans grow tax-deferred, and withdrawals in retirement are generally taxed at your ordinary income rate in the year of the withdrawal. A SEP plan can be established and maintained each year with less cost and administrative effort on your part.
If you’re self-employed, here’s some info you might want to know about these popular plans:
- You may contribute up to 25%1 of your compensation2 or $61,000 (whichever is less) for 2022 and $66,000 for 2023.
- You can contribute to a SEP every year you are self-employed and have earned income, regardless of your age.
- You can adjust your contribution amount each year as the situation warrants.
- You have until your business’ tax filing date plus extensions to set up and fund a SEP.3
- You must start taking required minimum distributions (RMDs) in the year you turn 72. (See: Make the most of required distributions)
If you take a distribution before age 59½, you would normally be subject to income taxes and a 10% early distribution penalty, although certain exceptions apply. The 10% penalty may not be imposed if the following conditions apply:
- You are totally and permanently disabled.
- You (and your spouse) are a first-time home buyer(s), in which case you can use up to $10,000 from your SEP to make a down payment on a home.
- You are using the distribution to cover unreimbursed medical expenses.
- You use the money to pay health insurance premiums while you’re unemployed.
- You use the money for qualified higher education expenses.
- You have a new baby or adopt a child. You may withdraw up to $5,000 from your IRA without a penalty. The withdrawal must be made within one year after the birth or adoption date. The distribution may be treated as a rollover and may be resubmitted to an eligible retirement plan or IRA.
- For more information, see Exceptions to tax on early distributions.
Although you would not pay a penalty on money withdrawn after 59½ (or if you qualify for an early distribution exception), you would owe taxes on all distribution at your ordinary income rate for the current tax year.