Can a Sole Proprietor SEP Plan Still Make Traditional IRA Contributions?

Simplified employee pension individual retirement accounts (SEP-IRAs) allow sole proprietors to stash extra money in a tax-deferred retirement plan as both the employer and the employee. Having a SEP-IRA as a sole proprietor won't reduce your traditional IRA contribution limit, but it might affect your deduction, because even though you're working for yourself, the SEP-IRA counts as an employer-sponsored plan.

SEP-IRAs allow sole proprietors to make contributions to the plan as an employer rather than as just an employee. Even though you might just be a one-person freelancer, you can still have a SEP-IRA. When you contribute as the employer, that doesn't affect your traditional IRA contribution limit, because you're using a different limit altogether. Your SEP-IRA employer contributions are limited to the smaller of 25 percent of your earned income or $56,000 as of 2019, whichever is less.

You can also make your traditional IRA contributions for the year to the SEP-IRA. These contributions count toward your annual contribution limit for traditional IRAs, but not towards the employer contribution limits to the SEP-IRA. For example, say your earned income is $60,000 and your traditional IRA contribution limit is $6,000. You could contribute $15,000 to the SEP-IRA as an employer and $6,000 to either your SEP-IRA as an employee or another traditional IRA.

Participating in a SEP-IRA, even when you're a sole proprietor, means that you're covered by an employer-sponsored retirement plan. Unfortunately, this means that if your modified adjusted gross income is too high, you can't deduct your traditional IRA contribution. The limits change between filing statuses and adjusted for inflation from year to year. For example, as of 2019, you can't deduct any of your traditional IRA contribution if you also have a SEP and your MAGI exceeds $74,000. If you're married filing jointly and your spouse has a retirement plan through their employer, the threshold goes up to $203,000.

To ease the pain of losing your traditional IRA deduction, the IRS uses phaseout ranges rather than absolute income limits. For example, in 2019, if you have a SEP-IRA and your MAGI falls between $64,000 and $74,000 if you're single, your maximum traditional IRA deduction is lower. How much lower depends on where in the range you fall.

If you're close to the bottom of the range, say, $64,000 if you're single, most of your deduction is still safe. But, if you're just under the upper, you only qualify for a minimal deduction.