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Guide to Self-Employed Pension Plans
Let Uncle Sam pay for part of your retirementThese plans all offer tax-deductible contributions. And money inside the plans grows tax-free until you take it out. Three keys to finding the right one:
- Retirement plan choices for the self-employed all have key differences, so you need to investigate carefully which one is right for you.
- The most significant differences are: how much money you can put in and what happens if you add staff later on.
- According to the American Institute of Certified Public Accountants (AICPA), you can't fully fund more than one in a single year, so you need to make a wise choice.
Action Steps
The best contacts and resources to help you get it done
Fly solo with a 401 (k)
The Solo 401(k) is great if your business is raking it in and you need to catch up on retirement savings. A generous contribution formula lets you sock away a larger portion of earnings at a lower income level than with other plans. You can also borrow against a Solo 401(k) -- handy if you fear locking up your money long term.
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AICPA has complete Solo 401 (k) details in a great site called 360 Degrees of Financial Literacy. The IRS has a good PDF download 401 (k) Plans for Small Business. The 401 (k) Help Center is a terrific place to discover plan details and download a Directory of 401 (k) plan providers. The Small Business Channel has advice on how to choose the best plan and find plan vendors. See how much you can contribute to a Solo 401 (k) with a contribution calculator. Do it all online with The Online 401 (k) for small business.
SEP-IRAs work for one-person shows
The SEP-IRA is great if you run a one-person show and intend to keep it that way. Open one at virtually any bank, mutual fund company or brokerage firm. The contribution limit is 25 percent of net income up to $44,000 (adjusted periodically for inflation). If you hire help later, however, funding rules can make this plan costly, and loans are not allowed.
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One appealing SEP-IRA feature is funding flexibility. These plans let you wait until you file your taxes to fund the plan. So if your income turns out to be higher or lower than expected, you can adjust your contribution to fit. See how a SEP plan works and how to establish a SEP.
Get sophisticated pension power with a SIMPLE IRA
The SIMPLE IRA is good for entrepreneurs who aspire to run bigger businesses.
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Even if you add employees, you can keep the same plan. But "SIMPLE" stands for "savings incentive match plan for employees," so you will have to match employee contributions up to three percent of pay. AICPA has complete SIMPLE IRA details. Also check how a SIMPLE IRA works and how to establish a SIMPLE IRA.
See side-by-side comparisons
Plan features are different, and confusing. See how they stack up.
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The IRS publication Choosing a Retirement Plan Solution for your Small Business (PDF) has handy side-by-side comparison charts that can help you choose the best plan for your needs.
Tips & Tactics
Helpful advice for making the most of this Guide- As a supplement to a SIMPLE plan, consider adding a Roth IRA. While the Roth isn't really a business owner plan, it's a great option if you have more savings available after fully funding a SEP, Solo 401(k) or Simple IRA. You can put the maximum $4,000 into a Roth ($5,000 if 50+) if your adjusted gross income is under $110,000 ($160,000 for married couple). You get no tax deduction for the contribution, but money grows tax-free and withdrawals are tax-free in retirement.
- If your business is really booming and you want to set aside even bigger dollars, consider a profit sharing plan. This option is more complex and it's a good idea to talk with a CPA or other retirement plan expert about setting it up.
- One drawback of the SIMPLE IRA is a low contribution limit. You can stash away no more than $10,000 per year ($12,500 if you are 50 are older), which might be too little.
