With a new year starting, many of us are making resolutions to do things right. We may vow to exercise,
eat healthier, or spend more time with our families. Maybe we’ve pledged to take control of our finances and
set more aside for retirement.
If you are in this latter group, this article is for you! Self-employed writers can easily set up a retirementaccount. Saving for retirement isn’t only a way to ensure that your golden years are comfortable, it can also
save you some money in taxes since you can deduct contributions now and defer the income tax until you
withdraw the funds during retirement. Chances are you’ll be in a lower tax bracket at retirement than you
The most common retirement plan for self-employed taxpayers is what’s known as a SEP-IRA. The term
SEP stands for Simplified Employee Pension. A self-employed taxpayer may make contributions each year up
to the lesser of:
- 25% of the net earnings from self-employment, or
- the annual maximum dollar amount ($50,000 for 2012 and $51,000 for 2013).
As you will note, the annual maximum is subject to adjustment for inflation.
If you base your contributions on net earnings, be aware that ”net earnings” is defined as your gross income
less allowable business expenses, your SEP-IRA contributions, and the deductible employer portion of
your self-employment taxes (as computed on Schedule SE and deducted on Line 27 of the Form 1040). As
you may have realized, this computation contains a circular reference and can be tricky to compute. Fortunately,
IRS Publication 560 ”Retirement Plans for Small Business” contains a worksheet for computing the
annual contribution limits.
As noted above, contributions are deductible in the year the contributions are made, which reduces taxable
income and therefore cuts current taxes. Income tax is deferred until distributions are taken.
Do you participate in an employer-sponsored retirement plan, such as a 401(k), at a ”day job?” No problem!
Even if you contribute to another plan, you are still eligible to make tax-deductible contributions to a
SEP-IRA. In fact, contributing to both plans can maximize your retirement savings and significantly decrease
your current taxes.
Flexibility is another reason why SEP-IRAs are popular. With a SEP-IRA, you decide how much you want
to contribute each year (within the contribution limits noted above). You do not have to contribute every
year. This flexibility is wonderful, as it allows writers to make contributions in years when finances are good,
but allows them to skip a year or make smaller contributions when finances are tight. Moreover, unlike a traditional
IRA wherein contributions must cease once participants turns 70 ½, self-employed persons who
continues to earn net income from their business can continue to save for retirement via a SEP-IRA even
after they turn 70 ½. With people living much longer these days, the additional years of contributions can be
a big benefit.
Setting Up a SEP-IRA
It’s easy to set up a SEP-IRA. The instructions for Form 5305-SEP and the information in Publication
560 will tell you how. You can access the forms and publications at www.irs.gov. In addition, many financial
institutions will help you set up a SEP-IRA.
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