Why Choose a SEP IRA?
If you are trying to decide between a SEP IRA and a traditional IRA, you should know that SEP IRAs are especially designed for self-employed individuals. One of the main advantages of a SEP IRA is that there is an increased contribution limit. For 2016, business owners have the option to contribute up to 25 percent of their income or $53,000, whichever is less. However, if you have employees, you are also required to contribute the same percentage to the SEP IRAs of eligible employees. The limit for self-employed individuals is calculated using the individual’s net earnings reduced by ½ of SE tax and by the SEP contribution amount. A SEP IRA may be a good option if you plan to continue working as a one-person company because the contributions are tax deductible and you have the flexibility to contribute as your budget allows.
Traditional IRA Benefits
For a traditional IRA, the contributions are set at a maximum of $5,500 if you are under the age of 50 and $6,500 if you are age 50 or older. A traditional IRA offers the option to obtain a tax deduction which will lower your adjusted gross income and ultimately your tax liability. You won't have to pay any taxes on the contributions that you make until you withdraw the funds or you are age 70½. In addition, you can also maintain a traditional IRA even if you have other retirement plans. The contributions are also protected from creditors during a bankruptcy.
Where to Deduct a SEP IRA on Your Tax Forms
Line 28 of Form 1040, Self-employed SEP, SIMPLE, and qualified plans, should be used to report the contributions that you made for yourself to this plan as a deduction on your 1040. However, if you've made contributions on behalf of an employee on the same plan they should be reported elsewhere on your return.
Where to Deduct a Traditional IRA on Your Tax Forms
For traditional IRAs, you may take a tax deduction for that contribution by reporting it on Line 32 of Form 1040, IRA deduction. This IRA deduction can be taken regardless of whether you take a standard deduction or you choose to itemize your deductions.
Filing and Tax Requirements to Be Eligible for Either Plans
For both traditional and SEP IRAs, you must meet certain filing and eligibility requirements in order to set up these retirement plans. For single individuals the modified adjusted gross income limit for a traditional IRA is $132,000. For married couples filing joint returns, the limit for a traditional IRA is $194,000.
To establish a SEP IRA, a 1099 contractor must establish an agreement to provide benefits to all eligible employees of a business, even if you are a one-person business. Each employee must have earned at least $600 for the year and have worked for the employer for at least three out of the five years prior to the year in which the contribution is made. For 1099 contractors that make in excess of $255,000, this compensation may not be considered for the purposes of making SEP contributions.
If you need advice on setting up an individual retirement account, contact Shared Economy CPA for further assistance.