by Mat Sorensen | Sep 21, 2022 | Investing
A SEP IRA is a powerful retirement account used by many self-employed persons and business owners. It is particularly attractive as you can contribute up to $61,000 into it annually. That’s in comparison to a Traditional IRA, where you can only contribute up to $6,000 a year. “But what if I have employees? If I have employees in my business do I need to offer then plan and contribute for them?” The answer is “yes” and “no,” as it depends on your employees. The devil’s – or perhaps we should say loopholes – in the details.
Employer Contribution
Keep in mind that the money contributed to a SEP IRA is an “employer contribution.” This means that the money comes from the company and is set at a maximum of 25% of the employee’s wage. So, if you are the only employee and you make $100,000 that year, the company can contribute $25,000 to the SEP IRA. For a business owner with no employees, it doesn’t really make a difference whether you pay into the SEP IRA from your company’s account or from your personal account as its all effectively your money in the end.
However, once you have employees, you are required to offer the same SEP IRA and same employer contribution to them that you offer to yourself. Now, you will likely care whether that money comes from the employee’s wages or from the company’s account. So, let’s say you had an S-Corporation and had a W-2 of $100,000, and you had one employee who had a W-2 of $40,000. The company would contribute $25,000 to your SEP IRA account (if doing the 25% max rate) and would also contribute $10,000 to the employee’s SEP IRA. While you, as the business owner, may be excited about contributing $25,000 into your own SEP IRA from the company’s funds, you may be less excited about contributing $10,000 to an employee’s SEP IRA account from the company’s funds. But, this is what’s required if the employee is eligible.
Employee Eligibility Loophole and Flexibility
The good news is that you only need to offer the SEP IRA to “eligible employees,” and you can make employees “ineligible” if they have not worked for you for 3 years out of the prior 5 years (see IRS SEP IRA FAQs). In other words, until someone has worked for the company for at least 3 years, you do not need to offer the SEP IRA to them. For many small businesses, self-employed persons and new companies, a SEP IRA can be an excellent choice for the business owner as they may be the only eligible person who has worked for the company for 3 years. You can also restrict eligibility if an employee has not yet turned 21. This 3 year employee eligibility rule under a SEP IRA is far superior to the 1 year employee eligibility rule that would apply when using a Solo K upon hiring employees.
Keep in mind that you are subject to the same eligibility rules. So, if this is a new company, then the strategy of offering the plan to yourself while restricting others doesn’t work so well. But, as is usually the case, if you have worked the business for years before having an employee, then you can set the work year requirement to make yourself eligible while setting it out up to 3 years for any employees.
If an employee has worked 3 out of the prior 5 years and is now eligible, the business owner can decide to cease the SEP IRA plan (and their own contributions), and can instead move to a 401(k) or other more common retirement plan structure where the company is not required to offer such a generous employer contribution.
A SEP IRA can be self-directed and invested into real estate, LLCs, private stock, notes, and precious metals. Directed IRA establishes SEP IRA accounts for self-directed investors and you can set-up an account entirely online. Learn more now at www.directedira.com.
Mat has been at the forefront of the self-directed IRA industry since 2006. He is the CEO of Directed IRA & Directed Trust Company where they handle all types of self-directed accounts (IRAs, Roth IRAs, HSAs, Coverdell ESA, Solo Ks, and Custodial Accounts) which are typically invested into real estate, private company/private equity, IRA/LLCs, notes, precious metals, and cryptocurrency. Mat is also a partner at KKOS Lawyers and serves clients nationwide from its Phoenix, AZ office.
He is published regularly on retirement, tax, and business topics, and is a VIP Contributor at Entrepreneur.com. Mat is the best-selling author of the most widely used book in the self-directed IRA industry, The Self-Directed IRA Handbook: An Authoritative Guide for Self-Directed Retirement Plan Investors and Their Advisors.
by Mat Sorensen | Oct 31, 2017 | News
If you are self-employed and use a SEP IRA to save for retirement, you should carefully consider moving those funds to a new Solo 401(k) (aka “Solo K”).
Both SEP IRAs and Solo Ks are retirement plans commonly used by self-employed persons with no employees, such as: Real estate professionals, investors, consultants, direct-marketing professionals, 1099 salespersons, and other small business owners. Here’s why: Both the SEP IRA and the Solo K offer big annual contribution amounts that far exceed the $5,500 ($6,500, if over 50) that you can put into a Roth or Traditional IRA. In fact, in both the SEP IRA and Solo K, you can contribute, depending on your income, up to $54,000 annually – $60,000, if over 50 in a Solo K. That’s almost ten times the contribution limit of an IRA. And, if you’re really trying to build up a retirement account you can retire on, you’re going to need to contribute more than $5,500 a year.
Now, if you have a SEP IRA, you should really look at changing that SEP IRA to a Solo K. Sure, SEP IRAs are good, but Solo Ks are great. Here are four major reasons why you should make the switch:
1. You Can Contribute More to a Solo K on Less Income
You can contribute more to a Solo K each year on less income. Let’s consider the following example: Sally is 41 and the 100% owner of Sally, Inc. She sells products online and Sally, Inc. is taxed as an S-Corp. The total cash flow income from her company is $8,000 and she ends up paying herself a W-2 of $40,000 for the year. Based on the $40,000 W-2, she could contribute the following amounts:
- SEP IRA – 25% of Wage Income: $10,000
- Solo 401(k) – $18K on the first $18K Wage Income, plus 25% of Wage Income: $28,000
That’s right: Sally can contribute $28K a year to her Solo K on a $40,000 W-2. If she was using a SEP, she’d only be able to contribute $10,000. The significant difference is that, under a Solo K, you get to contribute $18K on the first $18K ($24k, if 50 or over), plus you get to contribute 25% of the wage income.
Also, if you are looking to max out the Solo K contribution amount of $54,000, then you’d need to have a W-2 from the S-Corp of $144,000. However, if you were looking to max out contributions at $54,000 using a SEP IRA, then you would need to have a W-2 of $216,000. Bottom line: It’s easier to max out your retirement plan contributions with a Solo K. And, at lower W-2 levels, something S-Corp owners strive for, the contribution difference is significant. For more details on Solo K contributions, please refer to my prior blog article.
2. You Can Self-Trustee and Administer Your Solo K
All IRAs, including SEP IRAs, must have a third-party custodian – a bank, credit union or trust company – for the account. However, with a Solo K, you can self-trustee and can have control of the bank checking account and/or a brokerage account without having a third party as the trustee. This allows you to invest directly out of the Solo K and gives checkbook control. A valuable tool when investing a retirement account into alternative assets like real estate, notes, or private companies, as you can sign off on investments or process funds without waiting on a third party to process and approve your own funds.
3. You Can Loan Yourself Up to $50K from a Solo K
Under a Solo K, you can loan yourself half of the balance of the Solo K not to exceed $50,000. This is known as a “participant loan,” and is a great option to use when you need to access funds you’ve contributed and saved for retirement. Maybe you need funds to grow the business, pay for school expense, or take a trip to Vegas. Whatever the reason, good or bad, your hard-earned money can be accessed without penalty under a Solo K using the participant loan. Now, you will need to pay the funds back over five years with a set interest. But, this money goes back into the Solo K you’ve been building. For more details on the 401(k) loan, please refer to my prior blog article. Unfortunately, the participant loan cannot be done with a SEP IRA, and would actually result in a distribution, penalty and taxes.
4. No UDFI Tax on Leveraged Real Estate with a Solo K
If you self-direct your SEP IRA plan into real estate, you may have heard of a tax called “unrelated debt financed income” (or “UDFI”). This tax applies when you leverage your SEP IRA’s cash with debt. For example, you buy a rental property with your SEP IRA for $100,000. Of this $100,000, $40,000 comes from your SEP IRA’s cash and $60,000 is from the bank loaning your SEP money on the deal. By bringing in 60% debt to the investment, the IRS will require tax on 60% of the net income from the profits of the property. However, this tax on leveraged real estate does NOT apply to Solo Ks as Congress created an exemption for Solo Ks, but not SEP IRAs. So, if you self-direct and leverage real estate investments with debt, you’d be crazy to use a SEP IRA over a Solo K. The tax can be tricky to calculate for IRAs and requires a separate 990-T tax return. Check out my detailed webinar on the topic if you’d like to learn more.
There are a couple of downsides to the Solo K over a SEP IRA:
1. Solo Ks are more expensive to set up, as it requires an IRS-compliant plan document. Expect to pay around $1,000 – $2,000 for an IRS-compliant Solo K that you can self-direct and self-trustee. Under both a SEP IRA and a Solo K, you will have similar on-going annual fees to keep them compliant.
2. The other downside to a Solo K is that once you have $250,000 in assets or more in a Solo K, you must file a 5500-EZ tax return to the IRS each year. This return isn’t overly complex, but it is an annual filing requirement you’ll need to handle, or hire someone else to handle if you are self-administering your Solo K.
So, what if you have a SEP IRA and you want to move over to a Solo K? You’ll first need to establish a Solo K for your business by adopting an IRS-compliant Solo K plan. Once you do that, you can start making your new contributions into the Solo K and also roll over the existing funds from your SEP IRA (or other traditional IRAs).
by Mat Sorensen | Mar 28, 2017 | News
You have until April 18th, 2017 to make 2016 IRA contributions for Roth and Traditional IRAs. If you’re self-employed and are using a SEP, your deadline is determined by your company’s tax filing deadline (e.g. s-corp, partnership, or sole prop). So, if you were an s-corp or partnership in 2016, then your filing deadline was March 15th, 2017. II you are a sole prop, then the deadline is April 18th, 2017. If you extended your company return, that extension will also apply to your SEP IRA contributions. The table below breaks down the deadlines and extension options for Traditional, Roth and SEP IRAs.
| Type of IRA |
Contribution Type |
Deadline Details |
| Traditional IRA |
Traditional, Deductible |
April 18th, 2017: Due Date for Individual Tax Return Filing (not including extensions). IRC § 219(f)(3); You can file your return claiming a contribution before the contribution is actually made. Rev. Rul. 84-18. |
| Roth IRA |
Roth, Not Deductible |
April 18th, 2017: Due Date for Individual Tax Return Filing (not including extensions). IRC § 408A(c)(7). |
| SEP IRA |
Employee, Deductible |
N/A: Employee contributions cannot be made to a SEP IRA plan. |
| Employer Contribution, Deductible |
March 15/April 15th: Due Date for Company Tax Return Filing (including extensions). IRC § 404(h)(1)(B). |
|
|
|
As outlined above, you have until the 2016 individual tax return deadline of April 18th, 2017 to make 2016 Traditional and Roth IRA contributions. The deadline for Traditional and Roth IRAs, however, does not include extensions. So, even if you extend your 2016 tax return, your 2016 Traditional and Roth IRA contributions are still due on April 18th, 2017.
SEP IRA contribution deadlines are based on the company tax return deadline, which could be March 15th if the company is taxed as a corporation (“c” or “s”) or partnership, and April 15th if it is a sole proprietorship. Keep in mind that this deadline includes extensions, so if you extend your company tax return filing, you will extend the time period to make 2016 SEP IRA contributions.
by Mat Sorensen | Nov 25, 2014 | News
Retirement account/plan contributions are one of the most powerful tax strategies you can implement but you’ve got to make them by the deadline so that they can reduce this years tax liability. With the end of the year fast approaching, now is the time to make certain you are maximizing this important tax strategy for your 2014 tax planning. Please find below a table outlining the deadlines for 2014 retirement plan contributions according to your type of retirement account. If you are self-employed, you’ll notice the deadline also may depend on the type of company you own (e.g. s-corp or LLC) but also whether you are making contributions as an employee of your company and/or as the employer. First, let’s summarize the IRA contribution deadlines.
IRA Contribution Deadlines
| Type of IRA |
Contribution Type |
Deadline Details |
| Traditional IRA |
Traditional, Deductible |
April 15, 2015, Due Date for Individual Tax Return Filing (not including extensions). IRC § 219(f)(3); You can file your return claiming a contribution before the contribution is actually made. Rev. Rul. 84-18. |
| Roth IRA |
Roth, Not Deductible |
April 15, 2015, Due Date for Individual Tax Return Filing (not including extensions). IRC § 408A(c)(7). |
| SEP IRA |
Employee |
N/A; employee contributions cannot be made to a SEP IRA plan. |
| Employer Contribution |
March 15/April 15th, Due Date for Company Tax Return Filing (including extensions). IRC § 404(h)(1)(B). |
| Simple IRA |
Employee Elective Deferral |
January 30, 2015. IRC § 408(p)(5)(A)(i). |
| Employer Contribution |
March 15/April 15, Due Date for Company Tax Return Filing (including extensions). IRC § 408(p)(5)(A)(ii). |
In summary, for traditional and roth IRA contributions you have until the individual tax return deadline of April 15, 2015 to make 2014 contributions. SEP and SIMPLE IRA contribution deadlines are based on the company tax return deadline which could be March 15th if the company is a corporation and April 15th if it is a sole proprietorship or partnership. Keep in mind that this deadline does NOT include extensions so even if you extend your personal tax return filing to September 15, 2015, you still have a April 15, 2015, contribution deadline for Roth and Traditional IRAs.
401(k) Contribution Deadlines
| Solo 401(k) |
Business Structure |
Type of Cont. |
Deadline Details |
| 401(k), including self-directed Solo 401(k) (plan must be adopted by 12/31/14) |
Sole Proprietorship |
Employee Elective DeferralContribution |
April 15, 2015, contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and election should be made by December 31, 2014; IRS Publication 560. Rev. Rul. 76-28; 90-105. |
| Employer Profit Sharing Contribution |
April 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014. IRC § 404(a)(6). Rev. Rul. 76-28; 90-105. |
| S-CorporationOr C-Corporation |
Employee Elective Deferral contribution |
March 15, 2015 (corporation filing deadline), contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and election should be made by December 31, 2014; IRS Publication 560. Rev. Rul. 76-28; 90-105. |
| Employer Profit Sharing Contribution |
March 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014. IRC § 404(a)(6). Rev. Rul. 76-28; 90-105 |
| Partnership (e.g. partnership LLC) |
Employee Elective Deferral Contribution |
April 15, 2015 (partnership return filing deadline), contribution deadline is Due Date for Employer Tax Return (including extensions) but compensation must have been earned by December 31, 2014 and Election should be made by December 31, 2014; IRS Publication 560. Rev. Rul. 76-28; 90-105. |
| Employer Profit Sharing Contribution |
April 15, 2015, Due Date for Company Tax Return Filing, including extensions, however employee compensation must have been earned by December 31, 2014. IRC § 404(a)(6). Rev. Rul. 76-28; 90-105. |
There are a few important things to keep in mind regarding 401(k) contributions.
401(k) Contribution Deadlines Can Be Extended
First, the contribution deadline for employer and employee contributions is the company tax return deadline INCUDLING extensions. So, if you have a solo 401(k) you can extend your company tax return and your contribution deadline is also automatically extended. For example, if you have a solo 401(k) plan adopted by your s-corporation, then your s-corporation tax return deadline is March 15, 2015, but that can be extended 6 months until September 15, 2015, upon filing an extension to extend the company tax return with the IRS. If you do this, you’d have until September 15, 2015, to make the 2014 employee and employer contributions. That being said, the employee contributions are taken from your salary/wages and if you make traditional 401(k) employee contributions those amounts are reported on your personal W-2 and reduce your taxable wages. The W-2 is effectively where your tax deduction for traditional employee contribution arises is it reduces your taxable wages on your W-2. As a result, you’ll need to make or at least know the amount you intend to make for employee contributions by January 31, 2015 as that is the W-2 filing deadline for 2014.
New 401(k)s Must Be Adopted by December 31st
Second, if you are establishing a new Roth or Traditional IRA, you can create that new account at the time of the IRA contribution deadline. However, if you are establishing a new solo 401(k) plan, you must have the plan established by December 31, 2014. Because there are a number of documents and procedures required to create a new 401(k) plan, this is not something that can be left to the last minute and you should start immediately if you intend to open a 401(k) this year.
Make 2014 Contributions in 2014
And lastly, while the deadlines for most 2014 retirement plan contributions for IRAs and 401(k)s runs into 2015, to keep things simple and stress-free we recommend making 2014 contributions by December 31, 2014, when possible.
As you can see, the contribution deadlines vary depending on the type of account/plan but also on the type of contribution. With respect to contributions to a self-directed solo 401(k), the contribution deadline also varies depending on the type of company you own that has adopted the plan. Therefore, it is important that you understand these deadlines and don’t miss out on an opportunity to maximize your tax deductions. For guidance on the contribution limits in 2014, please click here.
As previously stated, it is not too late to setup a retirement account/plan if you have not done so already. The deadline to set up a 401(k) and to make contributions for 2014 is typically the last day of the year, although I wouldn’t wait until the last day or even the last week of the year to do so. If you are interested in setting up a self-directed solo 401(k), please contact us immediately as we are helping clients establish these and so that we can get it set up before the end of the year.
A SEP IRA is a powerful retirement account used by many self-employed persons and business owners. It is particularly attractive as you can contribute up to $61,000 into it annually. That’s in comparison to a Traditional IRA, where you can only contribute up to $6,000 a year. “But what if I have employees? If I have employees in my business do I need to offer then plan and contribute for them?” The answer is “yes” and “no,” as it depends on your employees. The devil’s – or perhaps we should say loopholes – in the details.
