SEP IRA Contribution formula for Employees | Ed Slott and Company, LLC

SEP IRA Contribution formula for Employees

I am trying to determine how much I need to contribute to a SEP for an employee.

In reviewing the output on my tax software "SEP & Qualified plan worksheet" it reads as follows:

a) Plan Contribution rate 25%
b) Self Employed rate: 20%

As I calculate the actual SEP contribution as percentage of self employment income it is 18.6%

What is the minimum percentage I can contribute for an employee?

You cannot use a lower % for your eligible employees than you use for yourself. If you use a plan rate of 25% for yourself, the required deductions leaves you with 18.6% of your Sch C income, but you must then contribute 25% of the employee's W-2 income. You could use 1% for the employee, but then you would have to use a plan rate of 1% for yourself as well.

You should keep in mind that there is only one plan contribution rate. When the plan contribution rate is 25%, it is applied to both the W-2 employee's and the self-employed owner's earned income. For the W-2 employee this is 25% of wages. For the owner this is 25% of net self-employment income (after that 25% employer contribution). This can be calculated by dividing the self-employment income (net business profit - 1/2 SE tax) by one (1) plus the 25% contribution rate = 1.25. This calculation is commonly simplified to 0.25/1.25 = 0.20 = 20% of the self-employment income. Note: The 18.587% rate applies to the net business profit and not the self-employment income. This number should not be used, because it only applies if the entire net business profit is subject to the full SE tax rate. If the total of W-2 wages (if any) + 92.35% of net business profit exceed the Social Security max wage base, this will not be true. I corrected my error that Alan caught.

spiritrider, re the 15.587%, did you mean 18.587%?


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