If you are an entrepreneur, independent contractor, or other small-business owner, you are also the retirement plan provider. You have to proactively save for retirement since you do not have an employer to simply divert part of your paycheck into a 401(k) plan or offer a matching amount.
Betterment now offers SEP IRAs, an acronym for Simplified Employee Pension-Individual Retirement Account, designed for self-employed workers’ retirement savings. It is a type of traditional IRA that holds contributions made by an employer (you, if you’re self-employed) and allows your money to grow tax free while lowering your taxable income.
SEP IRA plans are an excellent savings investment because they have a high contribution limit and are easy to set up.
With a SEP IRA, the business owner (you) sets up an IRA for each employee (again, that’s you). Only the employer can contribute, and the contribution rate must be the same for each qualifying employee.¹
At Betterment, we have made the process as simple as possible for busy independent contractors or freelancers; you can set up a diversified portfolio for your SEP IRA in five minutes.
Here’s a brief guide to Betterment’s SEP IRAs to help you better understand what they are, who should use them, and why they’re a good idea for self-employed workers.
Who can use a SEP IRA?
In general, SEP IRAs can be used by self-employed or small-business owners who do not qualify for a Solo 401(k) or who do not want to deal with the additional paperwork and annual tasks required for a Solo 401(k). With a Betterment SEP IRA, that includes:
- Small-business owners
- Independent contractors
- Sole proprietors with no employees
Why SEP IRAs?
Compared to some other retirement savings options for the self-employed, SEP IRAs offer a high contribution limit (up to $53,000 for 2015), lower fees, and easier setup.
What’s the setup?
Like other IRA and taxable account types at Betterment, SEP IRAs are easy to set up. During the online setup, you’ll print and fill out IRS Form 5305-SEP to keep for your records. This is required by the IRS, but you do not need to mail the form to the IRS or to Betterment.
What will I be invested in?
Like traditional IRAs at Betterment, SEP IRAs are invested in a globally diversified portfolio of ETFs with an asset allocation that is personalized based on your time horizon.
What are the limits on contributions?
If you have no employees, you can contribute up to the lesser of $53,000 in 2015 or 20% of your net earned income from self employment. For example, freelance designer Kat, who works alone, earns $260,000 in net self-employment income after her self-employed tax deductions this year.² She can contribute 20% of that, which is $52,000, to her SEP IRA. If Kat had $200,000 in net income, she could contribute only $40,000, the lesser of 20% of her net income and $53,000. If she had earned $300,000, 20% of her income would be $60,000, but her contribution would be limited to $53,000.
Why is this better than a traditional IRA or Solo 401(k)?
The benefit of a SEP IRA is that you can save much more money than you can in a traditional IRA. In 2015, you can contribute up to $53,000, compared to the $5,500 ceiling on traditional IRA contributions or $6,500 if you’re 50 and older. With a Solo 401(k), you could also contribute up to $53,000, but the overhead and administration can be more costly than for a SEP IRA.
Like other tax-advantaged accounts, SEP IRAs grow tax free, and contributions to the plan can reduce your taxable income.
What if I go back to working for another employer?
Businesses change and so do careers, so you can take your money with you if you need to move it from a SEP IRA. You can transfer funds into a traditional IRA, your new employer-sponsored plan, or into another SEP IRA, all without tax implications. You can also do a backdoor Roth conversion from a SEP IRA into a Roth IRA. Or you can leave it as is if you plan to have self-employed income again in the future.
When should I contribute?
Contributions for 2015 can be made in 2016 up to the due date of your tax return (April 15, unless you have any extensions). By postponing a full contribution until 2016, you can estimate your taxes before you contribute so you know what you have to save. You should consult your tax professional to discuss the tax implications of a SEP IRA to determine what is best for your personal situation.
What if I can’t contribute?
Bad year? Don’t put money into it. There is no need to contribute every year to keep the SEP IRA active. You can still contribute to a traditional IRA.
Can I contribute a SEP IRA and a work 401(k)?
Yes. This often occurs when someone has a self-employed income stream in addition to a full-time job with a retirement plan. There are some debates about what is the most effective way to maximize both accounts, so it is best to speak with your tax professional if you intend on contributing to both types of accounts. Also, contribution limits apply per person, not per plan, so your contribution limits on each account may be lower.
How Betterment’s SEP IRA compares to other options
|Type||Contribution Limits||Tax Deductible||Employees Allowed||Setup Cost|
|Betterment SEP IRA||It can be 20% of compensation, up to $53,000.||Yes||No||None with Betterment|
|SIMPLE IRA or SIMPLE 401(k)||For qualifying employees (earning more than $5,000), the 2015 maximum is $12,500. The employer can make a maximum 2% fixed contribution or a 3% matching contribution for each employee. “Catch up” with $2,500 extra per year if you’re 50 or older. (See IRS guidelines.)||Yes||Yes||Yes|
|Solo 401(k)||In 2015, you can contribute up to $18,000 as an employee plus up to 25% of compensation as an employer, as long as your total contribution does not top $53,000. If you are 50 or older, you can ‘catch up’ with an additional $6,000 ($59,000 total). Note that if you are also participating in another employer’s 401(k), these limits apply per person, not per plan. (See IRS guidelines.)||Yes||No||Yes|
¹ Betterment SEP IRAs can currently be used only by business owners who have no employees other than themselves.
² Net earned income = self-employment income – self-employment tax deductions, with a max of $265,000 net earned income in 2016.
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