So you didn’t get around to saving for retirement in 2015? There’s still time, thanks to rules that give you a grace period into 2016 to make 2015 contributions to an IRA, a Roth IRA, and for those with self-employment income, also a SEP-IRA. You could potentially sock away a total of $59,500 for 2015.
“Everyone’s looking for that last dollar of tax deduction, so the retirement plan contribution is wonderful from our standpoint; usually it’s a relatively big dollar amount, and it’s something they can do after the fact and have it go back and affect the prior year,” says Geoffrey Harlow, a CPA and partner at Kessler Orlean Silver in Deerfield, Ill.
Here’s a common scenario that plays out during tax season. Last year Harlow helped an executive laid off from a corporate job who became a consultant set up a SEP-IRA to shelter his consulting income. Many of the times the newly self-employed aren’t thinking of a retirement plan contribution, and they’re not even aware they can do it, Harlow says. “We make the suggestion, and they say, ‘I thought it’s too late;’ we play the hero; it’s not too late.”
The beauty of a SEP-IRA is that you can set one up for the prior tax year. You can open and fund the account until the due date for your 1040 individual income tax return, with extensions–meaning you can open one and make 2015 contributions until Oct. 15, 2016. Plus, you can do this for free or a minimal fee at most mutual fund outfits, brokers and banks.
Your annual SEP-IRA contribution, all of it pretax, can be as much as 20% of your net earnings, up to a maximum of $53,000 for 2016. That’s based on the amount you can contribute as an employer, as a percentage of your salary; the compensation limit used in the savings calculation is $265,000. (We’re assuming you operate as an unincorporated sole proprietor reporting your business earnings to the IRS on Schedule C. So that’s 20% of your net earnings after subtracting the one-half of your Social Security and Medicare taxes that are deductible.)
If you’re one person doing consulting then you’d want to maximize your SEP-IRA contributions and put in as much as you can, assuming cash flow allows it. If you have employees, there’s a catch. All the money you put into a SEP-IRA counts as an “employer” contribution, and you must make the same percentage contributions for all “covered” employees (other than your spouse). Covered, in this case, includes part-time employees who are at least 21 and who have been employed by you for at least three of the last five years and who earned at least $600 from you last year.
How do you get to $59,500? Employer contributions made under a SEP plan do not affect the amount you can contribute to an IRA on your own behalf. So you can both receive employer contributions to a SEP-IRA and make regular, annual contributions to a traditional IRA–or Roth IRA.
You can contribute up to $5,500 for 2015 ($6,500 if you’re 50 or older, thanks to a $1,000 catch-up rule) to an IRA or a Roth IRA (subject to income limitations). IRA contributions for 2015 can be made until April 18th, 2016; there’s no extension grace period as there is for the SEP-IRA.
Some SEP-IRAs let you make traditional IRA contributions, and the annual $1,000 catch-up contribution, to your SEP-IRA account. Note: There’s no Roth version of a SEP-IRA, so if you want a Roth IRA, that means opening up a separate account.
When is a traditional IRA better than a SEP-IRA? “We try to look at which approach allows you to put in the most money on a deductible basis,” says Harlow. Take the example of a self-employed spouse (relying on the other spouse’s income for living expenses) who earns $10,000. He could still put $5,500 in an IRA while a SEP-IRA would be capped at roughly $2,000. “Gee whiz, you’re better off putting the money into a traditional IRA,” Harlow says.
And what about those income limits on who can get a deduction? For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $183,000 and $193,000 (for 2015). You can still contribute to the traditional IRA if you’re over the income limits, just it’s nondeductible. If you’re covered by a workplace plan, including a SEP, the income limits are lower.
If you want some retirement money in a Roth for tax diversification and the ability to pull out contributions penalty-free at any time, you could go with a Roth IRA instead of a traditional IRA. Just watch out for more pesky income limits. Couples with adjusted gross income over $193,000 and singles with AGI over $131,000 (remember, AGI is after reductions for pretax retirement contributions) aren’t allowed to make annual contributions to Roth IRAs for 2015. Say you have $100,000 in self-employment income and contribute $20,000 to a SEP-IRA. If that’s your only income, a Roth contribution would be allowed.
Finally, while you’re thinking about your 2015 retirement savings, get ahead on 2016. Harlow says that clients will set up a SEP-IRA for year one of their new business, looking in the rear view mirror, and then planning ahead, set up a SIMPLE-IRA or 401(k) plan for the current year. They aren’t viable options for procrastinators to save for year one in year two because you can’t set them up for the prior year.
This article was written by Ashlea Ebeling from Forbes. This reprint is supplied by BNY Mellon under license from NewsCred, Inc.
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Ashlea Ebeling, Forbes Staff