If you own a small business and operate an LLC taxed as an S Corporation, you may be questioning if you can contribute to a SEP IRA.
What is a SEP IRA? A Simplified Employee Pension is a tax-advantaged retirement plan for small businesses owners and self-employed individuals to contribute toward their own and their employees’ retirement. It typically allows high, tax-deductible contributions with low administrative costs and no annual filing requirements.
In many cases you may be eligible, but could it be a smart move for your situation? Our Chief Investment Officer and Senior Wealth Advisor, Matthew Saneholtz, CFA, CFP®, EA, was recently quoted in a MarketWatch article, sharing his insight on who this could benefit. “Review how much you’re paying yourself through the S Corp payroll and depending on tax brackets, it might make sense to do a SEP IRA and Roth IRA.”
Could a SEP IRA Work for You?
Because of its structure, a SEP IRA can help business owners save more for retirement than a traditional IRA. There are conditions for S Corp owners, the first being that contributions must come from the business. Those contributions are based on your W-2 salary, not your total business profit. Also, you can generally contribute up to 25% of your W-2 income, up to the IRS annual limit. Lastly, you have until your tax filing deadline (including extensions) to make a contribution.
These conditions can cause confusion, since many S Corp owners may take a modest salary, then take additional profits as distributions. This can reduce payroll taxes, but it can also lower how much you’re allowed to contribute to an SEP, because your paycheck size can directly affect your retirement contribution limit. But would increasing your salary allow you to save more for retirement in a tax-efficient way?
Everyone’s situation is different and there is no one-size-fits-all answer. Your current tax bracket, how much you want to save, and your long-term financial goals are just some of the variables involved in a retirement strategy.
Do You Have Employees?
A SEP can become more complicated if you have eligible employees, since you must contribute the same percentage of pay for them as you do for yourself. For example, if you contribute 20% of your salary to your SEP, you must contribute 20% of each eligible employee’s salary as well. For business owners with staff or plans to hire, this could increase costs.
If you have no full-time employees, a solo 401(k) could provide more flexibility. It can allow you to contribute as an employee and employer and often make Roth contributions. However, once you hire full-time employees, you typically cannot keep a solo 401(k).
Retirement Planning Is Part of Business Planning
Choosing between a SEP IRA and solo 401(k) is a decision containing many variables, and everyone’s situation is unique. When you put together pieces such as how much you pay yourself, how you manage payroll taxes, your tax brackets, your hiring plans, and your long-term financial goals, retirement savings can become a powerful tool rather than just an obligation.
Eligibility alone doesn’t determine whether it’s the best option, and as Matthew shares, reviewing your situation can help you decide whether a SEP, Roth, solo 401(k), or even a combination, makes the most sense.
To learn more, we open the door to contact us. Retirement planning is personal, unique, and dependent on your long-term goals. If you’d like to chat about your particular situation, we’re here to help provide a clearer path for you to move forward with confidence.
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