Did I Just Find Another Great Retirement Saving Strategy? Understanding the SEP IRA Rules

Business-Man-Looking-With-Magnifier-300x300I think I may have found another good one.

A few weeks ago when I laid out my ultimate plan for becoming financially independent, I thought I had really done a pretty good job of optimizing every single angle of my retirement savings options.

My 401k.  My IRA.  Is there anything else I’m possibly missing where I could find even MORE tax-deferred savings?

Apparently there is!

And as it turns out it has a lot to do with this blog.  So all of my blogging friends or people earning any kind of side income may want to listen up …

Another Helpful Phone Call with Vanguard:

Over the Christmas holiday, I offered to help my sister explore her options for retirement savings.  Since she is a freelancer and basically self-employed, I knew the rules would be slightly more involved than the more conventional options that I am used to.

With nothing more than a few ideas in mind, I decided to call the people who would probably know best – Vanguard – and see what I could learn from them.

After only a few short minutes, I was chatting with one of their retirement specialists and our conversation seemed to focus on the subject of a SEP IRA (Self Employed Pension IRA).  (There will be a lot more info below on just what the SEP IRA rules actually are.)

From a self-employed perspective, this one really seemed to stand out among the other options.

But then the agent said something to me that I wasn’t expecting.  Something that was a game-changer.

“You know that you could contribute to one too ….”

One More Way to Grow My Money Tax-Free!

“I” could contribute to one to?

You see when we were talking about the actual mechanics of how this SEP IRA would work, I had mentioned that I too make a side income from my blogging efforts.

That’s when the Vanguard agent mentioned that you can contribute to a SEP IRA even if you participate in another retirement plan such as with another employer 401k.  I later independently verified this statement to be true.

So what does that mean?

It means that if you’re a full-time employee for some job (like myself) BUT you also receive some sort of income on the side, then you COULD contribute to a SEP IRA in addition to all your other retirement strategies!

That may not sound like a big deal.  But consider that the contribution limits can go as high as $52,000 in 2014!  That’s a lot of money you could potentially be stashing tax-free!

How Does This Benefit You?

Do you really like paying a bunch of taxes on your blogging income or passive income streams?  I sure don’t.  And I’d love to use any legal means out there I can to make that number as low as possible!

That’s what I like about this prospect!

Not only could I be lowering my overall tax bill, but it would mean that I would get to save more of my earned money.

Follow my logic.  If you’re like me, you probably:

  1. Do something that earns you a side income (for me, it’s this blog)
  2. You pay taxes
  3. Save or invest whatever is leftover

Recall in my post about Tax Deferred vs Taxable Retirement Income Strategies, we learned that the tax deferred savings route didn’t just beat the taxable one, it beat it by A LOT!  In one of the examples, we made over $1.9 million dollars more in accumulated wealth!  That’s no small chunk of change to disregard.

So that’s what I like about the prospect of using a SEP IRA.  My process would then become:

  1. Do something that earns you a side income
  2. Save or invest a portion of your earnings
  3. Pay taxes on whatever is leftover

That’s going to be a much better deal for me!

The SEP IRA Rules and Fundamentals:

Dollar-Symbols-Falling-From-Sky-300x272Here is more of what I learned about the SEP IRA rules:

The Basics:

To summarize, a SEP IRA looks and acts just like a regular traditional IRA.

  • (With Vanguard) There are no annual fees or establishment fees
  • You can invest in whatever you would normally invest in with your IRA today – mutual funds, stocks, etc.
  • Taxes are paid later in life when you retire rather than now
  • You can’t touch it until age 59-1/2.  Otherwise you have to pay that 10% early penalty.
  • There are required minimum distributions when you reach age 70-1/2


As it was explained to me, it helps to think of your SEP IRA in two parts:

  1. The employer.
  2. The employee.

If you are self-employed, then you are actually both and entitled to save on both sides of the fence.

As an employee, you get to save $5,500 per year in this SEP IRA.  HOWEVER, keep in mind that this does affect your ability to contribute to other types of IRA’s.  You can’t exceed $5,500 in any combination of IRA’s whether they be a Traditional, Roth, SEP, or anything else.  So if you’re already contributing to a Roth, then this part of the equation isn’t available to you.

Now on the employer side is where you reap the benefits!  As the employer of this self-owned business, you also get to make a total contribution that doesn’t exceed $52,000 (for 2014) or 25% of your income; whichever is less.

The definition of “25% income” is the tricky part, and the Vanguard agent advised that I seek the help of an accountant to assist with that.  Apparently the way that works is its 25% of your gross compensation.  So what exactly counts as “gross compensation”?  Is it Revenue – Expenses?  This is where you or I would have to speak to a true tax professional to figure it out.

So How Much Extra Money Would I Make?

To really illustrate how much extra money this strategy may or may not make me, let’s run through a simple real world example and see what the benefits would be.

So let’s say last year I added up all the revenue and expenses from my side income (my blogs) and decided (with the help of an accountant) that my gross compensation was $10,000.

My employer contribution to my SEP IRA would then be 25% x $10,000 = $2,500

That would leave me with $10,000 – $2,500 = $7,500 of taxable income.

If I’m the 25% tax bracket, that would be $1,750.

What if I hadn’t contributed to that SEP IRA?

Then my taxes would be 25% x $10,000 = $2,500

That means I got to keep an extra $2,500 – $1,750 = $750 by using the SEP IRA.

While that might not sound like a ton of money, consider that over a 10 year time frame with 8% inflation adjusted returns that $750 per year could grow into $9433!

No matter which way you look at it, I think we could argue that it would be worth it to at least speak to a professional accountant and see how I could go about taking advantage of this.

Readers – Does anyone already have or participate in a SEP IRA?  Were you aware that the SEP IRA rules allow you to invest a lot more than you may have previously understood it to?

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