Welcome to Two Minute Money, Yahoo Finance’s new personal finance series offering quick explanations for some of the most important questions involving your money.
You’ve launched your own business and love being self-employed, but you’re not sure where to start when it comes to saving for retirement. The good news is you’ve got options, including a Simplified Employee Pension Individual Retirement Account, or SEP IRA.
A SEP IRA similar to a traditional IRA, but it allows employers to contribute instead of employees.
With a SEP IRA, you can start with yourself and grow if with your staff as your business grows. As the employer, you’re allowed to contribute up to 25% of an employee’s pay, maxing out at $54,000 in 2017.
It gets a little trickier if you work for yourself. When you factor in self-employment taxes, the amount you’re able to contribute to a SEP IRA drops to 20% of your profit.
SEP IRAs can allow a lot more flexibility and are great for people with irregular incomes because you can contribute until the tax deadline—as late as October if you file for an extension. And you don’t have to contribute every year, which is nice if money gets a little tight.
The contributions you make to a SEP IRA are tax deductible, which means your money grows tax-free, though you’ll have to pay taxes on it when you withdraw it in retirement.
SEP IRAs also have their setbacks
First, the requirements are pretty strict when it comes employees. If you have a worker who is older than 21, earns at least $600 per year and has worked for you in at least three of the past five years, you’ll have to contribute to their SEP IRA if you contribute to your own.
You don’t get to cherry pick which employees get contributions each year—it’s either everyone who qualifies or no one.
Like other IRAs, you have to pay a fee for withdrawing money before you turn 59 and a half. You are required to start taking money out of your SEP IRA once you turn 70 and a half, so you can’t just leave it in there forever.
Just 8% of self-employed people put money into an IRA or an employer plan for retirement.
Don’t follow that trend. Build a nest egg now with a SEP IRA so you can kick back and relax during retirement.