SEP IRA Contribution Limit Guidelines

You can make an SEP IRA contribution instead of an alternative retirement account contribution if you are self-employed in a corporation or sole proprietorship. This type of retirement account is designed for a self-employed individual, but there are two different categories of self-employed person. The first owns an incorporated business and receives wages using a W-2 from that business. The second is a sole proprietor of an unincorporated business who collects payments as personal income. Your maximum contribution and contribution guidelines will depend on which category you belong to.

Incorporated SEP Contributions

The maximum SEP contribution limit is set annually. For the 2009 tax year, the limit is $49,000. However, if you earn $50,000, you cannot contribute all but $1,000 of it to your IRA. Instead, there is a maximum income percentage you can contribute. This is set at 25 percent for an individual who receives a W2 payment from a business he or she owns. For example, a business owner who is paid out of the profits of the corporation may receive a wage of $90,000. Then, this individual can contribute up to $22,500 into the IRA. If the owner receives a salary of $196,000, she can contribute the maximum $49,000, and this sum does not change for any additional salary earned. It is the maximum contribution amount.

Personal Income SEP IRA Contributions

Some business owners are actually sole proprietors. Whatever income the business brings in, the owner receives directly in pocket. The contribution limits are lower for this person, at only 20 percent of the annual net adjusted profit. It is important to remember, though, that this is the net profit and not the gross profit. Therefore, expenses must be deducted from income prior to determining how much a sole proprietor can contribute tax-free. If a graphic designer earns $60,000 this year and spends $10,000 on supplies, health care and other expenses, then the individual can contribute 20 percent of $50,000, or only $10,000 to the SEP IRA.

Tax-Free Contributions

The limits on any IRA account are set because the IRS must provide a barrier to how much tax-free income a person can make in a year. For example, imagine an individual inherited a large sum of money and does not need to live off of his or her income. Or imagine a person who earns $300,000 a year as a business owner. That person could, hypothetically, place 75 percent of the income into a retirement account. The individual would then be taxed as if he or she earned only $75,000 a year. This would be unfair to other business owners. Setting a maximum contribution limit assures that a wealthy individual with a huge salary cannot simply avoid taxes on the vast majority of his or her salary. This is also a way for the IRS to encourage saving without undermining its own ability to collect income tax, a large supply of funding to the federal government. The good news is, though, that the $49,000 yearly contribution is very high for the vast majority of individual business owners or sole proprietors.

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