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It is true that contributions to a retirement plan can only be made from compensation, which, in the case of a self-employed individual, is earned income. Distributions you receive as a shareholder of an S corporation do not constitute earned income for retirement plan purposes.
You can’t make contributions to a self-employed retirement plan from your S corporation distributions. Although, as an S corporation shareholder, you receive distributions similar to distributions that a partner receives from a partnership, your shareholder distributions aren’t earned income for retirement plan purposes (see IRC Section 1402(a)(2)). Therefore, you also can’t establish a self-employed retirement plan for yourself solely based on being an S corporation shareholder.
Your employment from the S corp (your salary) is allowed. SEPs provide a simplified method for you to make contributions to a retirement plan for yourself and your employees. Instead of setting up a profit-sharing or money purchase plan with a trust, you can adopt a SEP agreement and make contributions directly to a traditional individual retirement account or a traditional individual retirement annuity (SEP-IRA) set up for yourself and each eligible employee.
Because other employees, the company also must make contributions to their accounts. If you do not set this up for your employees too, then you are correct, you cannot use this for your contributions.
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