Calculating your retirement-plan and deduction for self-employed
Self-employed individuals ought to calculate a retirement plan contribution for themselves. The retirement contributions are calculated based on participant compensation. Calculate your self-employment using your net earnings from your self-employment. However, you need to adjust your net earnings from your self-employment to be able to determine the plan contribution or deduction for yourself.
Self-employed retirement savings plans
There are 4 options for retirement savings. Some are IRA-based and others 401(k) plans.
- SEP IRA
- SIMPLE IRA
- Keogh Plan
When you choose among the 4, your contributions will be made tax-deductible. You won’t pay taxes over the years as they grow. You only withdraw when you are 59 ½ because early withdrawals will bring penalties. Sometimes, you can get cash exemptions.
Plan compensation for a self-employed individual
When calculating your compensation plan, you need to reduce your net earnings from your self-employment by:
- The deductible portion of the SE tax and
- The amount of your own retirement plan contribution.
Use your compensation plan to calculate your own amount.
Your plan compensation and the plan deduction/contribution directly depend on each other. Use the reduced plan contribution rate as you need one to calculate the other.
Retirement plan contributions
Consider taking self-employed retirement plan contributions when going into business for yourself. When you contribute to SIMPLE IRAs, SEP-IRAs, and solo 401 (k) s, you reduce your tax bill, and you will be able to rack tax deferred investment gains for use later.
In 2019, you could contribute much as $19,000 in a deferred salary. If you are 50+ years old, make a $25,000 plus extra $6,000 catch-up contribution. Add another 25% of net self-employment earnings after removing half of self-employment tax contributions for yourself up to a maximum of $56,000.
Deducting retirement plan contributions
The total limits on plan contributions largely depend on the plan type you choose. View the available contribution limits for your plan. The limit is applied on the annual compensation amount, which determines the retirement plan contributions. The limits are usually adjusted annually ($280,000 for 2019).
In case you contributed more than what your plan term allowed, ensure you collect this plan qualification failure using the IRS correction programs.
How to contribute to a retirement plan
Determine the self-employed individuals earned income as the net profit amount deduced from Schedule C or Schedule K-1 for a partnership. Use the calculator below to determine your maximum contributions for varying types of small business retirement plans like an individual (k), SEP-IRA, or SIMPLE IRA.
*Earned Income = Net Profit – ½ of Self-Employment Tax – Contribution.
Simple IRA plan limits
You can make salary reduction contributions of up to $13,500 IRA plan now in 2020, $13,000 in 2019. If you are aged over 50, make catch-up contributions by adding $3,000 between 2015 and 2020.
If you are in more than one retirement plan, you can make salary deferrals e.g., 401 (k) or 403 (b) plan. Ensure your annual employee contributions don’t exceed $19,500 in 2020. You need an additional $6,500 if you are aged over 50 for 2015-2019.
However, the SIMPLE IRA will limit your contribution to $12,500 plus another $3,000, which is the maximum you can contribute to your SIMPLE IRA plan.
Your employer must match deferrals for your salary on a dollar-for-dollar basis offering up to 3% of your compensation.
Or, your employer can make a non-elective contribution worth 2% of your compensation i.e., no more than $285,000 of the compensation in 2020.
SEP plan limits
SEP plans only allow employer contributions. For SE persons, contributions are limited to 25% of the income from your self-employment. Look into these tables and worksheets and learn how you can calculate your plan contribution.
If your sponsors an additional plan to your SEP e.g., profit sharing 401(k) plan, the amount you contribute for yourself may not exceed 25% of the earnings, you make from being self-employed. They could go up to $57,000 for 2020. Salary deferrals are not subjected to the 25% limit. Catch-up contributions are not included in the $57,000 limit.
The bottom line
That was a good introduction to tax deductions even though they might get complicated than stated. Here are the main deductions that can be made: tax preparation fees, credit card processing fees, repair and maintenance of the business property, equipment, and office supplies. Other business expenses can be amortized.