Self-Employed? Here's How a SEP IRA Can Help You Save Money in 2024

If you're self-employed, you might be looking for ways to save more money for retirement while reducing your taxes. Along with other tax-advantaged retirement accounts like traditional IRAs and Roth IRAs, self-employed people have another special option to invest for retirement: a Simplified Employee Pension (SEP) IRA.

With a SEP IRA, self-employed people and small business owners have a flexible, powerful option to sock away extra money for retirement. Depending on your small business income, you can save even more money for retirement with a SEP IRA than employees can save with their 401(k) plans.

Let's look at how a SEP IRA works, why it might be a good idea for your small business, and how it can help you invest for retirement while saving money on taxes.

Simplified Employee Pension (SEP) IRA: How it works

You can set up a SEP IRA with a brokerage or investment firm, in the same way as opening an IRA. For example, Charles Schwab, Fidelity, and Vanguard all offer SEP IRA accounts. Self-employed individuals, freelancers, and small business owners can set up a SEP IRA for themselves and their employees.

A SEP IRA is a type of traditional IRA, and it works in the same way as a traditional IRA: The money you put in can be tax deductible. But there are complex rules and limits on how much money you can put into a SEP IRA. It depends on the type of business structure you have, how much net business income you have, whether you have employees, and more.

For 2023, employer contributions to a SEP IRA for each employee can be up to $66,000 or 25% of compensation, whichever is less. If your small business has employees, the employer must contribute to the SEP equally for all eligible employees, and the money is immediately 100% vested -- your employees own 100% of the employer contributions to their SEP accounts.

If you're a self-employed individual, it's a bit more complicated to figure out how much you can contribute to a SEP IRA. The IRS defines a self-employed person's "compensation" for SEP IRA contributions as your net earnings (gross business income minus business expenses) from self-employment, after deducting half of your self-employment tax and deducting contributions to your SEP IRA.

So don't assume that as a freelancer or solo entrepreneur, you can just put 25% of your gross business income into a SEP IRA tax free. The exact amount you can put into a SEP IRA and deduct from your taxable income depends on a few factors. Talk to a professional tax advisor and/or your brokerage to make sure you understand the IRS rules for how much money you can put into a tax-deductible SEP IRA.

How to save money on taxes with a SEP IRA

A SEP IRA can be a flexible way for small business owners and self-employed people to save more money for retirement while reducing their taxable income. In fact, you can save even more money for retirement with a SEP IRA than you can with a 401(k) plan: The maximum amount that individuals can contribute to a 401(k) for 2023 is $22,500, while the most you can put into a SEP IRA is $66,000.

Another reason why a SEP IRA can be a great retirement savings tool for business owners is that you are also allowed to contribute additional money to traditional IRAs and Roth IRAs or to your SEP IRA as an individual, outside of your SEP IRA plan's employer contribution. For example, as described on the IRS website, Nancy, age 45, is the owner and sole employee of a small business. She contributes the maximum employer amount to her SEP IRA for 2023 ($66,000). She can also make additional contributions to her SEP IRA as an individual employee, up to the 2023 contribution limit of $6,500. This $6,500 amount could also be put into a Roth IRA, or split between a Roth IRA and traditional IRA/SEP IRA.

Want to save money on 2023 taxes? It's not too late! You can deduct contributions to a SEP IRA as long as you make the contributions by the 2024 due date of your tax return for 2023. Talk to a brokerage about opening a SEP IRA for your small business, and see if you can make prior-year contributions for 2023 -- even though 2024 is already here.

Bottom line: If you have a successful small business and you meet the IRS guidelines for how to contribute to a SEP IRA, this can be a great way to supercharge your retirement savings while saving money on taxes. Just make sure you understand the exact rules for how much you can contribute to a SEP IRA as an employer or self-employed individual, based on your business income. Talk to an accountant and your brokerage to make sure you're following the IRS limits, so you can avoid costly mistakes and penalties.