The self-employed have the same retirement needs as anyone else, and they may have more money to invest and deduct. The problem is that they don’t have a benefits employer offering carrots in the form of retirement benefits, so they have to grow their own. Below are some ideas.
SIMPLE ANGER – it’s just that – simple. The name is an acronym for Savings Incentive Match Plan for Employees. These plans are designed for small businesses with no more than 100 employees who earned $5,000 or more in payroll in the previous calendar year, but some tax advisors and professionals think these plans are more suitable for much smaller businesses. They generally recommend them for employers with seven or fewer employees and for someone who isn’t making a lot of money and therefore doesn’t have much to retire on. However, advisers agree that they are simple. The instructions and application are approximately four pages long and you can probably complete them in 10 minutes.
Questions and answers
• Who can open one? Generally an employer with no more than 100 employees.
• Cost and complexity? Under.
• Use contribution limit? Three percent of employee salary, matched, or two percent non-elective.
• Employee contribution limit? $11,500 for 2009.
• Annual reporting requirements? None.
SEP IRA: The Simplified Employee Pension Plan is just as easy and affordable to set up and maintain as a SIMPLE IRA. With the difference that instead of the employee making contributions to the plan with a matching match from the employer, the employer makes the full contribution. Freelancers may find the SEP ideal due to its low installation and maintenance costs. Business owners can save slightly more in a SEP than in SIMPLE or other IRAs. For 2009, the contribution limit is 25 percent of net income up to $49,000.
Questions and answers
• Who can open one? Any employer or self-employed person.
• Cost and complexity? Under.
• Use contribution limit? 25 percent of employee net income up to $49,000.
• Employee contribution limit? Does not apply.
• Annual reporting requirements? None.
Solo 401(k) – Similar to a 401(k), Solo 401(k) allows small business owners to share the fun and benefits in a slightly different way. The business must be very small, limited to the business owners and their spouses. The Solo 401(k) allows business owners to save more money than a SIMPLE IRA or SEP, and there is some flexibility when it comes to contributions. You can contribute more or less each year, but a maximum of $16,500 for 2009 and a profit-sharing component can also be added to the Solo-K. Business owners can add the profit sharing portion to maximize contributions to the plan. The employer can make a maximum tax-deductible contribution to the plan of up to 25 percent of compensation.
Questions and answers
• Who can open one? Self-employed business owners with no employees other than their spouse.
• Cost and complexity? Means, medium.
• Use contribution limit? $16,500 salary deferral plus 25 percent compensation, or $49,000, whichever is less, if a profit-sharing component is added to the plan.
• Employee contribution limit? Does not apply.
• Annual reporting requirements? Yes.
Defined Benefit Plan – The most expensive and complicated retirement plan for the self-employed. The defined benefit plan is more appropriate for someone looking for a large tax deduction. Employers can save a maximum of $195,000 per year, but generally need an actuary to determine how much can be contributed. It’s worth noting that the defined benefit plan will give you your biggest contributions, but it comes with strings attached. For example, you must have a plan document and most likely with an actuary. It will be the most expensive to do and will generally require an annual contribution.
In contrast, K-Only, SEP, and SIMPLE IRAs allow greater flexibility by allowing employers to reduce contributions in a low-cash-flow year.
Defined benefit plans can still be a good option for business owners who want to save as much money as possible on a tax-deferred basis.
You should be careful with most retirement plans. The IRS cracks down on plans sold by insurance agents and broker-dealers that feature life insurance plans within retirement plans. If the IRS classifies your retirement plan as a listed transaction or a reportable transaction, the IRS will not only disallow your deductions, charge you penalties and interest, but also penalize you for not coming forward.
