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Written by Erich M. Imphong, CFP®

Many small businesses or self employed individuals would like to contribute to a retirement plan, but have questions on which is the best for them. One alternative to a standard 401k plan that is less expensive to administer is a Simplified Employee Pension Individual Retirement Account, or SEP IRA. Here are some answers to some typical questions.

Who can contribute to a SEP IRA?

Self-employed individuals, sole proprietors, or independent contractors with 1099 income are typically eligible to make SEP IRA contributions. If you are an employee with only W-2 earned income, you are generally ineligible to establish and contribute to a SEP IRA. The SEP is most often used for the self-employed or small business owners that do not want to go through the complexity of establishing a 401k plan. For example, real estate agents with 1099 income from their broker would be eligible to contribute to a SEP IRA plan.

If I have qualifying income how much can I contribute?

Per the IRS, you may contribute the lesser of 25% of compensation, or $52,000 (for 2014; $53,000 for 2015).

Can I contribute to both a SEP IRA and a Traditional IRA?

I am often asked if you can contribute to both a SEP IRA and a Traditional/Roth IRA. The simple answer to this is “yes”. Individuals eligible to make SEP IRA contributions may also make either Traditional or Roth IRA contributions depending on income levels. There is no income phase out for Traditional IRA contributions, however contributions to Roth IRA’s are phased out for married couples with an AGI of $183,000 to $193,000 and for single filers with an AGI of $116,000 to $131,000. See The Backdoor Roth IRA blog post for a strategy to contribute to a Roth if your income is above phase out.

When is the contribution deadline?

You may make your contribution for the current tax year no later than on April 15 of the next year. If you file an extension, you have until the extension deadline to fund the SEP IRA. For example, your 2014 SEP IRA contribution must be made by April 15, 2015. If you file an extension, you would have until October 15, 2015 to make your 2014 contribution.

Are SEP IRA contributions pre-tax?

Yes! SEP IRA contributions offer a tremendous opportunity for income tax savings by reducing your taxable income by each dollar contributed. With a 401k plan you are limited in your pre-tax deferral up to $18,000 for 2015, but for SEP IRA’s you can contribute up to $53,000 for 2015. The caveat, however, is your earned income needs to be high enough to qualify for these larger pre-tax contributions. Contributions as noted above are limited to 25% of compensation. Regardless, there are tremendous benefits to for tax free growth combined with tax saving contributions.

How much I can contribute to a SEP IRA? An example:

If you are a sole proprietor, and you have net business profits of $50,000 you must first go through the steps to calculate your adjusted earned income. It is important to consult your tax advisor to correctly arrive at this figure. Once calculated, multiply this amount by the percentage to which you want to contribute to your SEP IRA (not to be higher than 25%). For example, if your adjusted earned income is $37,174, your 2014 contribution cannot exceed $9,294 ($37,174 X .25).

Are there limitations to what I can invest in with my SEP IRA?

As a general rule, you may not invest in life insurance and some derivative investments in any kind of IRA – this includes SEP IRA’s. However, SEP IRA’s give you the benefit of investing however you want to align this retirement account to your overall investment objectives. The benefits to what you can invest here far outweigh the limitations on what you can’t. I encourage you to consult your advisor to find what makes the most sense for your situation.

Investments: Not FDIC Insured • No Bank Guarantee • May Lose Value. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Past performance does not guarantee future results, and the likelihood of investment outcomes are hypothetical in nature.

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© Geier Asset Management, Inc. March 2015. Erich Imphong is a Client Manager and Assistant Portfolio Manager for Geier Asset Management, Inc., a Registered Investment Advisor. The above blog reflects the opinions of Mr. Imphong and not necessarily the firm. Any advice given is general in nature and investors must consider their own individual circumstances. Past performance is no indicator of future performance. The firm makes no warranties or representations of any kind relating to the accuracy or timeliness of the information provided.