DR 091: Don’t Make the Same $100,000 Retirement Mistake I Just Made

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If you have self-employed income in addition to your regular job, can you contribute to a SEP IRA even if you have a 401k at work? This question hit home for me a few years ago due to the income generated from this website. To get right to the point, the answer to the question is yes, as I’ll explain in a minute.

So what’s the $100,000 mistake? Based on my accountant’s advice, I mistakenly contributed far less to my SEP IRA than I could have. The mistake had to do with whether 401k contributions at work limit the amount you are entitled to contribute to a SEP IRA based on unrelated self-employed income. It was a painful lesson, as you’ll hear in the podcast. Here are the details.

Podcast of this Article

If an employee participates in his or her employer’s retirement plan, can he or she set up a SEP for self-employment income?

The IRS has answered this very question: “Yes. A SEP can be set up for a person’s business even if he or she participates in another employer’s retirement plan.” This answer comes from an IRS FAQ about SEP plans. That’s good news for bloggers, many of whom are employees with 401k plans in addition to self-employed income.

What are the tax advantages of an SEP-IRA?

The tax advantages are similar to a 401k. You can deducted your contributions and your earnings grow tax deferred. You will be taxed on withdrawals from an SEP-IRA.

What’s the maximum contribution to an SEP?

The maximum contribution depends in part on whether the contribution is for an employee or, in the case of those self-employed, the owner. For 2014, the maximum contribution on behalf of an employee to an SEP-IRA is the lessor of $52,000 or 25% of your ‘eligible compensation.’ For the self-employed, the contribution limit in 2014 is the lesser of $52,000 or 20% of earnings, according to the IRS.

Now to the question my accountant got wrong. Let’s assume that in addition to self-employed income you also have a regular job where you contribute to a 401k. Do your 401k contributions reduce the amount you can contribute to a SEP IRA. The answer is no, assuming that the 401k and SEP IRA are with two different companies not under common control. Why? While the employee contribution limits to a 401k are per person, the employer contribution limits (including a SEP IRA for the self-employed) are per plan.

And as always, consult a tax professional (not a blog) before making any decisions.

Where to Open a SEP IRA

In 2010 I opened a SEP IRA at Scottrade. I’ve been very happy with my decision, in large part because of the low trading costs and the option of visiting a physical Scottrade branch. You can check out a full list of the best brokers for IRA retirement accounts, too.

Published or Updated: July 23, 2014
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Kevin @ Change Your Tree says:

    Great information–thanks.

    I was actually wanting to look into this and it just happened to pop up in my feed reader.

    Yay!

  2. Tyler says:

    The question I’m still trying to find the answer for is: what if I have a 401k and an individual Roth IRA…can I still open a SEP-IRA through my side biz and contribute? I’ve found some people saying it’s fine, some people saying you can’t have your personal and a SEP IRA. What have you found?

    • DR says:

      Tyler, interesting question. Of course, you can contribute to a 401k and SEP as I covered in this article. In addition, in the context of Roth accounts, the IRS has stated that you can contribute to both an SEP and Roth IRA: “Yes, you can make a contribution to a SEP-IRA and a Roth IRA.” This is taken from a FAQ from the IRS. Obviously you should consult an SEP specialist. I’d suggest talking to the brokerage company with whom you plan to open the account. I have a rollover IRA with Vanguard, and they were very helpful in answering similar questions. Good luck!

  3. Jim says:

    This is helpful, but one remaing question: Does the emmployer match count toward the total 401(k) + SEP limit, or just what the employee contributed?

    • Fred says:

      I too am interested in the answer to this question. If my employer makes a contribution to my 401K plan, do I have to consider that contribution in calculating my SEP limits?

  4. JR says:

    Thank you for publishing the information. I do have a question however. I already have a SEP, have my own business and also work as contracted labor for another company. This other company issues me a W-2 and offers no benefits, i.e, the contract labor classification. Can I contribute up to 20% of my contracted wages from the W-2 as well as my net from Schedule C into my SEP, or must I open up another IRA, which doesn’t make sense since I won’t have the advantage of pooling all my retirement funds? Thank you.

    • DR says:

      JR, I would recommend that you take a look at IRS Pub. 560, which you can download from a link in the article. As you’ll see in Pub. 560, a common law employee cannot set up his or her own retirement plan such as an SEP from that income ( you have self-employed income too, which is a separate matter). Whether you are a common law employee depends on several factors, which are described in the publication.

  5. Alan says:

    I’m having a hard time grasping the maximum contribution part, even after reading through IRS Pub. 560. Maybe you can help if I supply details. Let’s say I make $40,000 at a regular job, and make $2,000 from blogging. I contribute $4,000 to my regular work 401k and $5,000 to a Roth IRA. How much can I contribute to a SEP-IRA?

    • Amber says:

      I think you can contribute to $2000 *.25 = $400.

      • Walter says:

        for self employed individuals the max percentage is 20%.

  6. Soyab Husein says:

    I have a small business and pay myself a salary (W2) and contribute 25% to a SEP IRA.
    In 2008 my children get an adhoc salary (ages 17 and 19 and on W2).
    Also, in 2008 I have an employee who also has another job with Company X where he participates in a 401K plan.
    I’m led to beleive that all employees on the payroll have to recieve the same %age of SEP IRA contributions.
    Since my employee is already in a 401K plan can I also contribute to a SEP IRA for him?
    If not, is there a legal obligation for me to compensate the employee and can I continue to contribute to my SEP IRA? Also, do I have to contribute to my childrens SEP IRA?
    Your answers will really be appreciated.
    Thanks.
    Soyab

  7. adam says:

    This is helpful, but one remaing question: Does the emmployer match count toward the total 401(k) + SEP limit, or just what the employee contributed? Could somone please answer this questions

    • Fred says:

      I’ll second this one here, too. I am looking for the answer to this question, which seems elusive.

  8. Jeff says:

    If you have a 401k and profit sharing plan that takes you to the max of $46,000, can you still contribute to a SEP_IRA for additional self employed income?

    • paul says:

      Contribution limits are governed by a couple of different rules.

      In short though, the maximium limit (46k in years past, 49k in 2010+2011) are combined from employee deferrals, plus match (401k) and profit sharing (401k/PSP or SEP).

      If you’re trying to maximize your deferrals from 2 different plans, it really pays to talk to a CPA as part of your tax filing… since many will also indemnify you if they do it wrong and you get a penalty.

  9. Laura says:

    Why do I have to take in my contributions to my employer sponsored 401k to reduce my contributions to my self employed sponsored SEP? In first case I am the employee and in the second case I am the employer. It seems like I only have to take into account all contributions if all contributions are made by the same employer.

  10. Diana says:

    If I have a small business and I already have a SEP established can I start a nwe 401(k) plan as well? I don’t want to contribute to both in the same year, but am I even allowed to start a new plan if the other exists?

  11. Gathering Sep IRA information and am happy to learn it won’t have to be an either/or situation. I can keep my other plan too.

  12. Ferdinand Cillis says:

    Thank god for 401k plans. Don’t know what we would do without them!!

  13. Trav says:

    I have 2 separate businesses. Can i contribute max to my solo 401kplan and max out a sep plan? thanks

    • Alwaysjammin says:

      Trav, I have the same question. I am GUESSING that it goes a total of 49k/person regardless of source of income. For instance, I have 2 companies: Company A with an individual 401k and Company B with a SEP-IRA. I am paid a salary of 40k from Company A which allows me to contribute 16,500+10,000 (25% of 40k) = 26,500. If I understand the article correctly, I can still contribute a maximum of 49,000 – 26,500 = 22500 from Company B via a SEP-IRA. Say that I make 80k in Salary from Company B, I can contribute 20K (25% of 80k) into the Sep-IRA. That is my understanding so far at least. Love to hear from others to see if this is accurate

  14. Max says:

    Have a w-2 with $ 5,000 in 401 k plan. 20% of my profit sharing plan from my schedule c is $ 45,000. Can I take the whole $ 45,000 or am I limited to $ 44,000.00.

  15. Crissy says:

    I have a business with 2 employees that has a sep in place. One employee is also employed full time at another job that will max is $50k in retirement contributions in 2012. Can my business with 2 employees still max the 25% contribution for the 1 employee since the other is already maxed elsewhere?

  16. SV says:

    I have maxed out my Roth 2012 contribution and want to add more funds to my SEP IRA for the same tax year. I have already gotten my tax refund (Fed and State for 2012). How do I report I’ve added additional SEP IRA funds for tax year 2012 to the IRS?

    • Rob Berger says:

      SV, I don’t have the answer to your question, but the following is a link to the IRS website page about SEPs–http://www.irs.gov/publications/p560/ch02.html

  17. DJ says:

    Hello DR:

    So I have a 401K at work and have maxed it out in 2012 ($17K I think). Me and my wife have our own part-time consulting business as well and have opened a SEP IRA. I can’t do any more personal IRAs (trad/roth) because we exceed the income limit.

    I am getting a lot of different answers on how much to contribute to SEP and if its taxable or not. The income from the consulting business is $20K each. I was initially told by one agent that I can contribute 25%, so will $4K be the right number for each of us?

    I am assuming this $4K will not be taxable or will this also be bound by the income limit?

    Any advice is truly appreciated!

    Thanks much. DJ

    • Rob Berger says:

      DJ, my understanding of the SEP IRA is that if you have employees, the figure is 25%. If you don’t have employees, the owner can contribute 20%. But that’s where you need to consult with a tax specialist to be certain. I suspect TurboTax could also walk you through this. Good luck!

  18. jk hide says:

    I have corporation for my business, opened 401K in dec-2013 and contributed 6000 as salary deferral and now want to know if i can contribute 25% of my salary into SEP plan vs contrbuting to 401K as profit sharing.

    • Rob Berger says:

      JK, this is a question you should ask a tax accountant. I’ve been told that for my business I can contribute each year to either a solo 401k or a SEP IRA, but not both. As for those who are self-employed, I believe the limit is 20% of income to a SEP IRA vs. 25% to a solo 401k. But again, with these issues I wouldn’t leave anything to chance. Talk to a tax accountant and/or retirement specialist.

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