A simplified employee pension is actually a traditional IRA that has some special rules. These rules allow small businesses and self-employed people to use SEPs to fund retirement savings. The contribution limit when you are self-employed depends on how much in earnings your business produces.
Maximum SEP Contribution
As of 2013, the maximum amount you can put into a SEP IRA each year is $51,000. The annual limit is adjusted by the Internal Revenue Service periodically. Contributions are tax-deductible. Your actual limit depends on your income. When figuring your SEP contribution limit, count only income from self-employment. Do not include any salary from another job if you are an employee there, and don't count investment or interest income.
Adjusted Net Earnings
To calculate your SEP contribution limit for self-employment, first determine your adjusted net earnings. These are equal to the business revenues minus all deductible business expenses. Net earnings must be adjusted by subtracting one-half of your self-employment tax, meaning your combined Social Security and Medicare taxes. As of 2013, self-employment tax is 15.3 percent of net earnings, so reduce your net earnings by one-half of 15.3 percent, or 7.65 percent. The easy way to do this is to multiply net earnings by 92.35 percent.
Your SEP Limit
You can contribute up to 20 percent of your adjusted net earnings from self-employment to a SEP IRA or the yearly dollar limit, whichever is less. Suppose your net earnings total $200,000. Multiply by 92.35 percent to find the adjusted net earnings of $184,700. Multiply $184,700 by 20 percent to find your SEP contribution limit of $36,940.
SEPs and Salaries
Use the self-employment method to figure your SEP contribution limit only if your business does not pay you a salary as an employee. This is the case for sole proprietorships, partnerships and some limited liability companies. If you are owner of a business such as a C or S corporation and get a salary, calculate your SEP contribution limit as an employee. The company makes the contribution on your behalf, up to the annual dollar limit or 25 percent of your salary. For example, if you are paid $160,000 a year, the business can add up to $40,000 to your SEP.