SEP IRA vs. General Investing

[hatgreeting]

Hi, I'm looking for a good explanation or article that details the tax advantage of a SEP IRA. I am considering starting a SEP as I have been self employed for a number of years, and plan on staying that way.

So far this is what I understand about a SEP IRA:

- Contributions are tax deductible
- Your account grows tax-free
- When you retire and take distributions, it's taxed like income

This is what I don't understand: If I carefully invest the money, and grow my account over my working life, won't I just end up paying taxes on a larger amount of money when I take my distributions? Also, depending on the amount I take every year, will that put me in a different tax bracket just like different levels of income would?

There doesn't appear to be much information regarding those subjects, and I'd like to know a little more before I lock a bunch of money into a retirement account. What I'm really looking for is something that breaks down the numbers.

Unfortunately, I am not eligible for a Roth IRA due to my income level, and it wouldn't help much anyway considering the low contribution limits.

[jIM_Ohio]

When you contribute it comes off the top.

When you withdraw it starts at the bottom.

Assuming you are married, here are some numbers to consider (using 2009 tax code):

Here is a website to use as reference:
Reference Room

right now you might earn 80k per year. Assuming married filing jointly:
For the first 16700 you are taxed at 10% ($1670 paid in taxes)
For the $16701 thru $67900 you are taxed at 15% ($1670+[15%*(67900-16701)]=9350 max taxes paid.
For the $67901 thru $137050 you are taxed at 25% (9350+[25%*(80000-67901)]=$12375 in taxed owed.

Coming off the top means if you put $10k into SEP, you reduce taxes at the top (25% level). The new math is:

9350+[25%*(70000-67901)]=$9875 in taxed owed.
Putting in 10k saved you $2500 in taxes. More of your money is being used by you now.

Let's say you find a way to squeeze another 3k into the SEP (13k total contribution, so 80k is now 67k taxed and 13k contributed to SEP).

Your taxes owed would be
($1670+[15%*(67000-16701)]=9215 taxes paid.

Contributing $13000 saved you $3160 in taxes. That is almost 25% of the 13000 because $12100 was deducted from the 25% bracket and the last $900 was supposed to be taxed at 15%.

If you are single, the savings is even more on same income (because the brackets are higher- 80k single is at top of 25% bracket and almost 28% bracket.

If you earn more than the brackets I listed, your savings will be even higher (28%-33%-35% are the tiered tax brackets).

When you withdraw you start at zero income and withdraws increase this. Bracket 1 is taxed at 10% bracket 2 is taxed at 15%...

standard deduction is 10700 and exemptions are 3400 each for you and wife. 10700+6800=17500. This means the first 17500 you earn this year and in retirement are tax free.

So if you earn 80k you get to subtract 17500 from it to begin with (62500) to figure out the taxed above- be sure to factor in your deductions before running the tax tables.

---
Withdrawing- the $13k saved you $3160 above.
When you withdraw the 13k, it is taxed at 10%, so tax liability is $1300. You saved $1800 in taxes.

If you saved the 13k in a taxable account, you would have only 10k left (which was already taxed, 3k was paid in taxes). The 10k grows and you could withdraw it tax free depending on investment.

You could pay $3100 in taxes now and have 10k
or $1300 in taxes later and have 12k.

[hatgreeting]

Jim, you are the man. This is the kind of technical detail I was looking for. Thanks a bunch for the detailed post and the link to Reference Room.

[jIM_Ohio]

glad I could help