If you are self-employed you have the option of a Self-Directed SEP IRA, which stands for Simplified Employee Pension, for part or all of your retirement plan.
In addition, a Self-Directed SEP IRA applies to small business owners, typically with up to 25 employees, who can also include a spouse, grown children, and other family members who are employees of the business.
Your Self-Directed SEP IRA allows an annual contribution up to $55,000 (for tax year 2018) per year (per individual). Contributions do not need to be scheduled or consistent, since only a few individuals would be able to contribute $4,583,33 every month. This tends to be ideal for those that earn quarterly or annual bonuses in large sums since the contributions are tax-free until such time as they are withdrawn.
This is where small business owners can take even more advantage of the high level of contributions allowed. Under this plan, an employer may contribute up to 25% of each employee’s annual compensation (up to $270,000 per employee) to the plan. Such a contribution, over the course of one year, would be in addition to the amount (up to $55,000) the employee contributes as an individual.
An employer can offer this, whether a corporation, partnership, or operating as self-employed. In order to be eligible, an employee must be at least 21 years of age, have been an employee of the business for a minimum of three of the past five years, and have earned a minimum of $600 in compensation. Again, this can include a spouse, grown children, and other family members who meet the appropriate employment qualifications.
However, an employer is required, under this plan, to have its contribution percentage between 0% and 25% of the earnings of each employee each year. For example, XYZ Corporation allots 6% of each employee’s earnings as its contribution. Since employee earnings generally vary based on the position and responsibilities, the amounts contributed will vary from recipient to recipient.
Since the amount each employee may contribute to his/her own plan also varies, operating a Self-Directed SEP IRA does not automatically mean that each participant in the same plan would have the same amount of contributions each year.
A self-employed individual does not need to be an employer or part of a corporation or partnership in order to participate. Thus, a real estate broker, insurance agent, or independent contractor (for example) is able to participate in a Self-Directed SEP IRA plan as well.
Suppose the owner of XYZ Corporation uses her Self-Directed SEP IRA for this purpose. Her choice is to use a portion of these funds to purchase real estate. She is able to sell a property she purchased earlier, and the sale generates a profit of $48,000.
Not only does this add another $48,000 to her fund (which she could re-invest in real estate or any other eligible purchase). The most important thing is that this would be in addition to whatever amount she contributes for the year. Thus, if she is able to contribute the maximum $54,000, her total contribution to her Self-Directed SEP IRA would now be $102,000 for the year.
Another advantage is that her business (XYZ Corporation) does not pay any taxes on the investment earnings within her Self-Directed SEP IRA.
This reflects the impact of doing a Self-Directed SEP IRA. Because it is self-directed, you are able to invest your funds in real estate, precious metals, notes, and certain related short or long-term investments.
Thus, it is not only the size of the contribution you are able to make (and possibly receive), but the ability to grow your funds through investments you elect.
There is still one more big advantage to a small business owner offering this to employees, including appropriate family members who meet the qualifications.
A Self-Directed SEP IRA also does not have the start-up and ongoing maintenance costs generally associated with managing a conventional 401K and/or profit-sharing plan!
As a result, it is possible that thousands of dollars of annual managing and administrative fees are saved by the employer. Even if the savings were “only” $2,500 per year, over the course of 20 years it means a long-term savings of $50,000.
Even without employees, many advantages remain to operating your Self-Directed SEP IRA.