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To SEP IRA Or Not To SEP IRA

Written by Kelly O'Connor

April 9, 2020

To SEP IRA Or Not To SEP IRA 

The #1 reason people are advised to put funds into these accounts is because of the apparent tax savings…because it “defers” the taxes. I like to use a more accurate term, POSTPONE because that’s truly what it’s doing. 

It postpones the tax and it postpones the tax calculation; therefore, we have to ask a couple questions: 

  1. What tax bracket will you be in at retirement?
  2. What deductions will you have when you take the money? 

The government can certainly raise taxes on your income level or you may, and it’s probably quite likely, EARN yourself into a higher tax bracket. Later on in life when you have no mortgage, the kids are gone and you may have sold your business can result in you being out of deductions. 

Does it make sense to dig into the math to ensure these types of accounts are actually beneficial? I think so. I prefer math over opinion anyway. 

Let’s take an actual example of a client of who owns a very successful HVAC business. This guy has about 50 employees and fleet of 25 vehicles and he’s spent the last 20 years building this business. I’ll call him Bill. 

Bill has something going on that I call, Concentrated Risk. This means all the money is in the business. Now, his CPA is doing a fine job saving him some taxes, helping him pay the least amount possible each year and maximizing his deductions. Bill had recently told his CPA that he wanted to put more effort in saving for his own retirement regardless of whatever happens to his business whether he can sell it and make a great profit or not. 

Bill had a couple issues because he was grossing about a $1,000,000 annually in personal income so obviously he was in the highest marginal tax bracket already. Plus, he enjoyed a wealthy lifestyle for sure. You see, his plan was always to sell the business and THAT was where his retirement money would come from; therefore, he had fun along the way living a fairly large life…two vacation homes, a gigantic home here in town, vehicles, toys, all the good stuff. 

Again, CONCENTRATED risk! The business WAS the entire plan. And this why he woke up one day and felt like he needed to back off a little on the lifestyle and use his own income to set aside some funds for the future. 

This type of lifestyle along with the future expectations mean he will almost assuredly remain in a high tax bracket when he retires. Plus, he’ll be virtually out of deductions since everything he owns is free-and-clear, the kids are gone and he won’t own his business anymore. It would almost be a crime to make recommendations to him based around a lower tax bracket in the future. 

The CPA gave him some interesting advice. His job is to reduce Bill’s tax burden for THIS YEAR! So he said, “We can put the wife on payroll, max out the catch-up provisions and we can direct a large amount into a SEP IRA.” At the time, he recommended Bill contribute $42,000. 

Bill and his wife were both 50 years old and their goal was to be done and retired in 10 years. 

To see how we demonstrated what an enormous mistake this would be for him, instead of writing a huge blog post, I’ll direct you to a video I recorded which demonstrates in detail the math behind our analysis. 

You can watch it here: https://youtu.be/WkyCVwVoRE8 

You’ll discover that the choice is quite easy. 

Message me, text me, call me, DM me, email me, or just get on my calendar for a brief call before you contribute any more to this type of an account and certainly before you start one. 

Kelly O’Connor

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