Starting a new business consumes much of your time.
As you learn to manage your time, there are immediate priorities and then those other priorities placed on your 'to do' list. Unfortunately, many entrepreneurs today consider setting up a retirement fund early in their new venture as something which can wait.
Waiting too long, however, can impact when you will be able to retire and with how much.
In the next three weeks we will be covering different retirement options available for small business leaders and entrepreneurs.
This week we will be reviewing the Simplified Employee Pension Plan (SEP).
What is a Simplified Employee Pension Plan (SEP) . . . in layman's terms
A Simplified Employee Pension plan (SEP) is where an employer (you in this case) puts a percentage of their income into an account, accessible when they retire.
When placing money into your SEP account, it is called contributing
As a sole proprietor, you can contribute up to 20% of each payment you receive.
Plus, you have the flexibility to make contributions when you're able. You're not required to make them with every check you receive, or even on a monthly basis. However, in order to build your SEP retirement account, it is recommended to contribute something with each payment.
What happens with the money in an SEP account? Does it just sit there?
Once you decide on a dollar amount you're going to contribute into your SEP retirement plan, it will be invested.
In this article, we're not going to focus on the different types of investments your money can be placed in. That is a topic to discuss with a financial advisor. However, there are a variety of investment options available to help grow your money.
Some options are riskier than others. Higher risk investments have more potential for bigger returns, but also for bigger losses. Lower risk investments, you may not lose much, but returns on your money will be smaller.
Again, this is a topic to discuss with a financial planner who can guide you in the right direction.
When you place a certain percentage of a payment into your SEP account, taxes will not be taken out of that portion.
As an entrepreneur, when you get a check, you first take out the amount you want to place into your SEP account; then with the remaining dollar amount, take out 30% of it for taxes.
You get a check for $1000. You decide to put $200 (20%) into your SEP account leaving you with $800. At that point, you take out 30% for taxes which ends up being $240. Now you are left with $560 to use how you please.
Another benefit to the SEP plan is the opportunity to take advantage of the tax deduction at the end of the year.
A deduction is a dollar amount excluded from taxes because it is considered a business expense. For example, buying office furniture, office supplies, treating a client to dinner, or having to travel to meetings are all expenses you should report to your tax advisor. Reporting these expenses will reduce the amount of taxes you have to pay.
This also goes for any contributions you make into your SEP account.
An SEP is considered a business expense and can be used as a tax deduction during your annual tax appointments.
Although your contributions before taxes were figured, that does NOT mean you will NEVER pay taxes on your SEP retirement balance.
Once you retire and begin to draw money out, your final SEP amount will be subjected to taxes. Government will take taxes out on money when you make a withdrawal.
However, the benefit to not having the amount you place into the SEP account taxed up front is that it will give you more savings when you do decide to retire.
If each SEP amount was taxed up front, you would end up with less to retire on.
Scenario A: You put in $100 each month for 30 years. You would end up with $36000 (not enough to retire but again, this is just an example).
Scenario B: If you put in $100 each month, however 30% was taken out for taxes, the total remaining to invest would be $70. Take that times 30 years and you end up with $25,200.
- You can contribute 20% of each payment you receive.
- The type of investments your money is up in will impact the amount you will be able to eventually retire on (again, contact a financial consultant to better understand your investment options).
- Each contribution is pre-taxed, allowing you to build your retirement fund before taxes are withdrawn.
- You can take advantage of the tax deductions at the end of each year until you retire.
Content contributed by Matthew Cassady, IASourceLink. IASourceLink is a proud affiliate of U.S.SourceLink, America’s largest resource network for entrepreneurs.