• Tweet

• Tweet

If you are self-employed, there are several options available in which you can save for retirement similar to the ways employees with company plans do across the country.

Most retirement plans for the self-employed are governed by the same restrictions as IRA and 401(k) accounts.  Typically, you have to pay a 10 percent penalty for withdrawing money before the age of 59.5.  Money withdrawn is taxed as ordinary income in the year you withdraw, unless you qualify for ten-year averaging, which means you’ll likely have to start withdrawing money by April 1 of the year you turn 70.5.

Everyone’s business situation is different, so it’s important to consult a professional for specific guidelines.  But if you’re curious about the options that are available, here is a brief explanation of the most popular self-employed retirement plans.

SEP-IRA

The SEP-IRA is a retirement plan for self-employed individuals, small business owners, sole proprietorships, S and C corporations, partnerships and LLCs. Popular because of its high annual contribution limit, it’s usually established by a business owner without employees but can also be started by a business owner with staff.

The 2012 SEP-IRA contribution limit is $50,000 (2011 limit is $49,000). Contributions are generally 100 percent tax deductible and investment earnings grow taxed deferred.

If you fund a SEP-IRA for yourself and have employees who have worked for you for three of the past five years, you are required to fund their SEP-IRAs too.  Keep in mind that these accounts are automatically vested, so if an employee leaves your company after it’s established, the money is theirs.

If you do not have employees, your contribution limit depends on how you receive compensation. If you receive a W-2, the annual contribution can be 0 to 25 percent of the W-2 salary up to the contribution limit. If you receive compensation as personal income, annual contributions can be made between 0 to 20 percent of your net adjusted self-employment income or business profits. The percentage of contribution can be changed at any time and may be skipped if you have a bad year.

Check with a financial adviser, but depending on your situation, you could have both a SEP-IRA and a Roth IRA. You could also convert a SEP-IRA to a Roth IRA because it allows you to invest more than the maximum allowed per year in a Roth. If your income meets requirements, you can deposit money in your SEP-IRA and convert it. You will have to pay taxes on the money after conversion, but you can subtract it from your income as a SEP-IRA deduction.  Look at you, being financially savvy!

Keogh

A Keogh is a bit more complex than a SEP-IRA, but it may allow you to save more. If you fund a Keogh for yourself, you must also fund one for employees who have worked for you for more than a year (there is a vesting schedule).

There are a few types, but the most common are money-purchase plans and profit-sharing plans, which allow up to a 25 percent annual contribution. When you open a money-purchase plan, you establish the fixed percentage of your own (and your employees’) net earnings that you will contribute each year going forward, even if you have a bad year.

Profit-sharing Keoghs allow you to decide your contribution on an annual basis, up to 25 percent of compensation (not including contributions for yourself) or $49,000 for 2011 ($50,000 for 2012).

It may be tempting to want to take a loan from your account, but if you own less than 10 percent of your business, expect to pay a 15 percent penalty each year there’s an outstanding loan amount. If you own more than 10 percent of your business, you cannot borrow from your account.

Defined Benefit Plans

A defined benefit plan is a traditional pension plan with a stated annual benefit you will receive at retirement. Contributions are required every year, whether or not there are profits, in the amount set by an actuary.  The amount is determined by various factors such as salary, years of service, expected returns on investments and more.

The maximum annual benefit can be up to $195,000 for 2011 ($200,000 for 2012).

SIMPLE IRA

A low-cost option, if you’re self-employed or have a small business with up to 100 employees, is a Savings Incentive Match Plan for Employees (SIMPLE). Staff can contribute a percentage of their salary and will receive some level of matching from you, as their employer.

You can invest up to $11,500 ($14,000 if you’re over age 50) in salary reduction contributions and either a fixed or matching contribution.

You can choose to match the dollar amount employees contribute to the plan up to a range of 1 to 3 percent of their salary. Alternatively, you can contribute 2 percent of the employee’s salary up to a set maximum per year, whether the employee actually contributes or not. These contributions are vested when they are made, so just like a SEP-IRA, an employee can withdraw the money if they leave the company.

Speaking of withdrawing, if you thought the 15 percent penalty for withdrawing early from a Keogh was bad, check this out. If you take money out of your SIMPLE plan within the first two years of opening it, the penalty is 25 percent (after that, it drops to 10 percent).  Let’s try to keep this account for awhile, alright?

Individual 401(k)

The Individual 401(k), also referred to as a Solo-401(k), allows one-person business owners (and their working spouse) to save for retirement.

It has the same contribution limits as a SEP-IRA, but you can save more at lower income because you fund the account as both an employer and employee.

For 2011, you can contribute up to 20 percent of your net self-employment income plus up to $16,500 in employee salary deferral, up to a maximum of $49,000. In 2012, those numbers increase to $17,000 and $50,000 respectively.

If you are 50 or older by the end of the year, you can make catch-up contributions of up to $5,500, for a maximum contribution of $54,500 for 2011 and $55,500 in 2012.

As you can see, there are several different types of retirement options for the self-employed, and only you and your financial adviser can determine the best plan for your situation. Owning a business is a lot of work, and you deserve to have a solid retirement when you are ready.  Take time to speak with a financial adviser to either craft a new, or tweak an old, retirement plan to maximize this important benefit.

 Printer Friendly Version