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Hello Fools.

I have been self employed for a couple of years, and this year I got my act together enough to start a SEP IRA account so I can squirrel some savings away. I have some pretty basic questions to make sure I don't mess up here.

I opened the account a couple of months back and have not made any contributions yet. I am under the impression that I can make the contribution as a lump sum. Is that correct? (I sure hope so)

Further, I am under the impression that I don't have to make that contribution by Dec 31st, but rather I can wait and see until tax time (April 15) how much my income was this year, and only then decide what 15% of that is, and hence determine my contribution. Am I right?

The contribution is based on the AGI (again, my impression - where the heck did I get these impressions anyway :-). And the AGI depends on my deductions, which the contribution is one. Isn't that a catch 22 situation? Do I just iteratively figure out a ballpark 15%?

Final question for bonus points: next year, I'd like to contribute as I go along, rather than in a lump sum. Under the assumption that it would be a Bad Thing if I over-contributed (how do you take money back out???), can I contribute conservatively as I go along, and then make a top-up payment to come up to the 15% at the end? I guess in general what I am asking is: do I only have the choice of contributing either regularly or in a lump sum, or can I contribute anything anytime so long as it adds up to the lesser of 15% or 30K?

Phew. That's a lot of questions. I am grateful for any answers.

BeenFooled
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Dear BeenFooled (me too, plenty)

1. You can wait until you do your taxes and then determine how much you want to contribute. But you must contribute by 4/15.

2. It is better to contribute as you go along. Since you get the benefit of tax deferred gains earlier and dollar cost averaging.

3. To figure out what you can contribute is a bit hard to understand. It is 15% of your taxable income, but after you take out the 15% as one of your deductions. Only the government could figure out something like this. That's why we called the "tax recover act", the "accountants and tax preparers full employment act".

It works out to 13.04348 percent. You do it like this. Take all your deductions except for the SEP IRA to see what your AGI would be. Let's say it is $10,000 for round numbers. Now ask yourself the question, "What do I subtact from $10,000 so that what is subtacted is 15 percent of what's left over".

Clear as mud? Like I said, only gov could come up with this. It's in their blood.

In algebra it looks like this; X equals what's left over after you subtact your SEP contribution; AGI is what you have before you subtact your SEP;

so X = AGI - SEP

And the ratio of SEP to X is .15

SEP/X = .15

multiply both sides by X and you get SEP = .15X

Substitute .15X into the first equation for SEP and you get:

X = AGI - .15X

Add .15X to both sides and you get:

1.15X = AGI

or X = AGI/1.15

So if your amount before the SEP is 10,000, you divide it by 1.15 and you get 10,000/1.15, or 8,695.65.

So your SEP contribution is 10,000 - 8,695.65 = 1,304.35. To check this out we ask, "is our SEP contribution 15 percent of our AGI after the SEP was taken out?"

1,304.35/8,695.65 = .15 (check!)

This is why I pay an enrolled agent to do my taxes. I hope they didn't change the rules since the last time I went through this. But that is how it was explained to me.

TOF
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Clarification/Confirmation please:

I see regularly on these discussions of the SEP IRA this 13.04348 - and I just want to run this by you guys:

This is true for those who are truely Self-Employed - those with sole proprietorships. As for the math in the previous post - I thought the 13.04348 was due to Self-Employment Tax and that you could only count 1/2 of that tax as income for the purpose of the 15% calculation because the other 1/2 is normally paid by an employer and not counted as salary for the calculation of 401k contributions etc...


I consider myself 'Self Employed' but I'm really an employee of a corporation wholly owned by me(an S Corp). In my case - I pay myself a salary of 150,000 - this costs my corp more than 150,000 - because of the company 1/2 of Social Security and Medicare - but that's moot - the 15% rule for me applies to the salary of 150,000. So my corp is contributing 22,500 to my SEP for me. I ran this by my accountant and he agreed - the 13.04348 does not apply to me because I'm not truely SELF-EMPLOYED.

How wrong am I?

Thanks
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How wrong am I?

Well, I'm darn sure hoping you're not wrong at all because that's exactly what I did....just put in the 15% of my gross salary (and my husband's, in his SEP IRA).

Sharyn, praying you're right
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TOF, in an otherwise excellent explanation of how to derive a SEP-IRA contribution for the self-employed, said in part:

<<It works out to 13.04348 percent. You do it like this. Take all your deductions except for the SEP IRA to see what your AGI would be. Let's say it is $10,000 for round numbers. Now ask yourself the question, "What do I subtact from $10,000 so that what is subtacted is 15 percent of what's left over".>>

AGI has absolutely nothing to do with it. It's income from self-employment and only income from self-employment that counts. AGI may be composed of wages from another job in which one is the employee, interest, capital gains, and dividends as well as a whole host of other income items. Thus, think "self-employed income," and banish any mention of AGI from the discussion.

Regards..Pixy
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Helter wrote:

<<Clarification/Confirmation please:

I see regularly on these discussions of the SEP IRA this 13.04348 - and I just want to run this by you guys:

This is true for those who are truely Self-Employed - those with sole proprietorships. As for the math in the previous post - I thought the 13.04348 was due to Self-Employment Tax and that you could only count 1/2 of that tax as income for the purpose of the 15% calculation because the other 1/2 is normally paid by an employer and not counted as salary for the calculation of 401k contributions etc...


I consider myself 'Self Employed' but I'm really an employee of a corporation wholly owned by me(an S Corp). In my case - I pay myself a salary of 150,000 - this costs my corp more than 150,000 - because of the company 1/2 of Social Security and Medicare - but that's moot - the 15% rule for me applies to the salary of 150,000. So my corp is contributing 22,500 to my SEP for me. I ran this by my accountant and he agreed - the 13.04348 does not apply to me because I'm not truely SELF-EMPLOYED.

How wrong am I?>>


You're not wrong at all. You are considered an employee of the S corp, and the S corp may have a SEP-IRA for its employees. In that sense, then, you're not truly self-employed and thus you're not limited to the 13.0438% as is a sole proprietor.

Regards..Pixy
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You are correct. I had precisely this situation.

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Here is another way to look at it that might eliminate the confusion about your status vis-a-vis your S-Corp. You are not self-employed. Instead, you wear two hats: one as an officer/shareholder of the corporation, who has no tax standing (at least not w.r.t. the current discussion), and the second as an employee of the corporation. As an employee, you are entitled to contribute to the same SEP-IRA that any other non-owner employees would be. Your salary from the S-corp is not self-employment income, as you have taxes withheld, and receive a W2 at the end of the year. The downside (depending on where you live) is that you may end up having to pay federal and state unemployment taxes, as well as having a workers compensation policy (I did). On top of that, your tax return is *MUCH* more complicated (not just your personal return, but the required corporate return).
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Thanks to all of you Fools that replied with help. I now have a much clearer picture on how I can work out my contribution, as well as some creative ideas on how to pay myself. All my income is from self employment but some is from personal consulting contracts, some from my S-Corp. Seems to me that there are schemes for my S-Corp to contribute to my SEP, as well as for myself to, maximizing my SEP contributions as well as my deductions. Will have to look into this further.

I do have a further clarification question. So long as I make quite sure I do not over-contribute, is it the case that it does not matter how I contribute? Ie I can put in contributions of any size and at any time (up to 4/15) so long as I don't exceed the magical maximum?

Thanks again, the Fool community ROCKS.
BeenFooled
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Yes, you're right. For lack of a better term we used AGI. But it's the self employed income after all your deductions we are interested in.

I stand corrected.

TOF
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BeenFooled asks:

<<So long as I make quite sure I do not over-contribute, is it the case that it does not matter how I contribute? Ie I can put in contributions of any size and at any time (up to 4/15) so long as I don't exceed the magical maximum?>>

Yes, you may do that should you so desire.

Regards..Pixy
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Hey Pixy:
thank a lot for all your help.
BeenFooled
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