You've put in the hard work and you're now reaping the rewards. You've officially made it.
Now that you've popped the champagne and drunk-dialed at least one ex to rub it in their face, it's time to start translating your success into a sound strategy for your long term financial wellbeing.
First let me say, all kinds of IRA can be excellent vehicles for long term wealth creation. What's different about each of them is that they all have different rules around how much you can contribute each year, how they are taxed - and whether or not you're contributing pre-tax, or post-tax money.
As with anything in the world of personal finance, the right decision will be the one which best takes into account your personal circumstances. Each of the IRA types have their own specific advantages and limitations, but there is one in particular which can be a great fit for people who are self-employed, but aren't yet big enough business to justify having a full 401(k) plan.
This is where the little-known SEP IRA can come in very handy.
SEP IRA stands for Simplified Employee Pension Individual Retirement Account. In essence, it functions like a miniature 401(k) plan and it's perfect for many people who run a small business. What makes it such a good fit is that it allows you to reduce your overall tax bill AND make a much larger annual contribution than either a traditional IRA, or a Roth IRA. Let's look at some facts:
Traditional IRA: $6,000, or $7,000 if you're over age 50
Roth IRA: $6,000, or $7,000 if you're over age 50
SEP IRA: $19,500, plus an additional $6,500 if you're over age 50
Traditional IRA: Yes
Roth IRA: No
SEP IRA: Yes
From the numbers above, it's pretty clear how a SEP IRA can benefit a small business person with cash to spare, especially if you're over age 50. It can be difficult to find a tax deduction that big in the normal course of business, especially one which is basically just you paying you.
When considering a SEP IRA, it's important to pay attention to some other details too. Firstly, the fact that you have to contribute the same percentage of your eligible employees' income as you do for yourself. So, if you're contributing 15% of your own income to the plan, you have to contribute 15% of your eligible employees' income too. An eligible employee is anyone who has worked for you for 3 of the past 5 years, has earned at least $600 from you in the past year and is over the age of 21.
This is why a SEP IRA is usually best for people with very few, or no employees (eg. a solopreneur). If you have a few eligible employees, you may be best served by starting a full 401(k) plan, for which the equal contribution requirement does not apply.
As with any type of IRA, there are restrictions on when and how you can access the money that you contribute to them.
It's best to plan for having any contributed amounts locked away for a long time, so if you think you might need to draw on it in the short term, don't put it in. As a general rule, one shouldn't contribute more than they can afford to have locked away until retirement. After all, that's what these accounts are really for...
If you've done the numbers and you'd like to open a SEP IRA account, simply click here to get started.
If you have a few employees and you think you'll be best served by starting a 401(k) plan, please send an email our resident 401(k) whiz, Brandon.
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