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SEP IRA Contribution Limit Increased to 25% of Compensation, Up to $40,000
The new contribution limit is a large benefit to self-employed taxpayers, allowing you to contribute up to $40,000 on compensation of $200,000.
Previously the maximum contribution allowed was 15% of eligible compensation, which was capped at $170,000. The maximum contribution has increased to $40,000, from $25,500 before 2002. The eligible compensation limit has been increased to $200,000.
Prior to 2002, self-employed taxpayers could contribute additional amounts by establishing a money purchase pension plan ("MPPP"). The MPPP enabled self-employed workers to contribute an additional 10% of compensation to a self-employed retirement plan.
The drawback to an MPPP plan is that the annual contribution percentage is defined when the plan is established. The contribution percentage is required each year, whereas SEP IRA contributions are optional each year.
With the expanded SEP contributions, there is no need to establish an MPPP to optimally fund your retirement plan.
One interesting detail to be aware of: the contribution limit for employees is 25% of compensation. For employers and sole proprietors, the limit is 25% of net profit. The contribution itself is deducted from the net profit, so the employer's or sole proprietor's own contribution is actually limited to 20% of income, up to a maximum of $40,000.
