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Why You Should Open A SEP IRA To Lower Your 2021 Taxes

David Rae, Contributor

Personal Finance

It is hard to believe, but tax season 2022 has already begun, meaning it is time to get ready to file your 2021 taxes. If you are self-employed or even have a side hustle, you may still be able to open a Simplified Employee Pension Plan (SEP-IRA) to lower your 2021 taxes. Contributions to a SEP-IRA can be a lifesaver for those of you who got a surprisingly large 1099 or a bigger tax bill for 2021 than expected.

You might be wondering, what is a SEP-IRA? It is a type of retirement account for Americans who have self-employment income or own their own businesses. The SEP-IRA is similar to a 401(k). You get a tax deduction for contributions, and you won’t be taxed on the account until you make withdrawals. One of the best features of the SEP-IRA is that it can be set up and funded after the tax year has ended and until you file your taxes for the previous year (including extensions). Other great retirement plans like a 401(k), profit-sharing plan, or defined benefit pension plan would need to have been established before the year ended.

2021 Contribution Limits for a SEP-IRA

You can sock away up to a fourth of your income up to the maximum limit. For 2021, the SEP-IRA contribution limit is $58,000. For business owners looking ahead to this year’s taxes, the 2022 SEP-IRA contributions limit is $61,000. All your contributions will be tax-deductible. Your actual allowable contribution will be based on your net income, so talk with your tax pro and fiduciary financial planner to help calculate the maximum you can contribute to your SEP-IRA. Simply put, you can contribute roughly 25% of your net income into a SEP in any given year, up to the contribution limit.

Who is a SEP-IRA Good For?

The SEP-IRA is great for business owners who work as sole proprietors on up to an LLC, Partnership, S or C Corp., specifically, those without employees (other than a spouse or family member). If your business has any employees, you will likely be required to contribute to a SEP-IRA for them at the same percentage of income you give to yourself.

A last-minute SEP-IRA can be a tax slayer for small business owners who are facing surprisingly large tax bills. Aren’t they all surprisingly large? Remember, you can open and fund a SEP-IRA retirement account after the tax year has ended and up until you file your taxes for the previous year. Think about it, would you rather write a check to your own retirement account or the IRS? That scenario is pretty much a no-brainer. Don’t you think?

You can still set up and contribute to a SEP for 2021.

If you are doing some last-minute tax planning for 2021, consider setting up a SEP-IRA. Your tax-deductible contributions can help minimize the taxes you owe for last year. If you are looking to minimize for 2022, check out a Solo 401(k) or Cash Balance Pension plan, both of which will offer larger savings in most business-owner scenarios. Both the Solo 401(k) and Cash Balance Pension plans need to be opened during the calendar tax year (aka before year’s end).

If you already have a SEP-IRA, now is the time to figure out how much you can contribute for 2021. If not, there is still time to open and fully fund a SEP-IRA for 2021. Talk with your trusted financial planner and tax pro about how much to contribute and how to best invest the fund to help you secure a more fabulous retirement.

Investing involves risk and investors may incur a profit or a loss. Past performance may not be indicative of future results. Withdrawals from tax-deferred accounts may be subject to income taxes, and prior to age 59 ½ a 10% federal penalty tax may apply. Diversification and asset allocation do not ensure a profit or protect against a loss. Holding investments for the long term does not ensure a profitable outcome. The foregoing is not a recommendation to buy or sell any individual security or any combination of securities.