It is no secret that being your own boss has its advantages, but what often gets overlooked is that the self-employed have more retirement plan options than regular employees. Potential plans include solo 401(k)s, Simplified Employee Pensions (SEP IRA) and Keogh Plans, and some advantages and disadvantages for each are below.
Solo 401(k) plans are available for self-employed individuals without employees or with only a spouse as an employee. For the full-time self-employed, and even for moonlighters, this is an excellent option. Participants can contribute to their plan as both the employee and the employer. As of 2012, those under the age of 50 can make elective salary deferrals of up to $17,000 of their earned income, as well as profit-sharing contributions of up to 25 percent of their net business profit, with the total contribution not exceeding $50,000. For those over the age of 50, the max employee deferral is $22,500, and the total contribution limit is $55,500. These limits are much higher than traditional IRA limits. Contributions are not taxable until withdrawal, and earnings are tax-deferred just as they are with traditional IRA accounts; however, there are solo Roth 401(k)s available in which contributions are taxed up front. There is no requirement for regular contributions. Solo 401(k)s are not as easy to establish and administer as SEPs. However, because of the profit-sharing contribution, you may be able to contribute more to the solo 401(k) than you can to an SEP.
T. Rowe Price, as well as discount brokers, stock brokers and insurance companies. Compare the investment options and account service fees prior to selecting.
With an SEP, any self-employed individual who operates as a sole proprietor or partner can contribute 25 percent of his net earnings up to $50,000 (2012 limits) per year, a much higher contribution limit than that of a traditional IRA. SEPs are easy to establish and administer. You have the option to convert to a solo 401(k) later if you wish to access the loan option (not available with SEP plans) or if you want to make larger contributions to your plan. One disadvantage is that if you have eligible employees, they must be included in the SEP. You cannot make a personal SEP contribution without making one to your eligible employees' SEPs as well. SEPs are available from the same administrators as regular IRAs, specifically mutual funds, stock brokers, banks and others.
With both solo 401(k)s and SEPs, withdrawal requirements and penalties are the same as with traditional IRAs. In general, there is a 10 percent penalty on distributions taken prior to age 59 1/2, and after age 70 1/2, there are mandatory withdrawal requirements based on IRS life expectancy tables. All withdrawals are taxed at ordinary income tax rates.
At one time, Keogh plans were the only option for self-employed individuals who wanted to contribute more than they could with IRAs. Since the introduction of solo IRAs and SEPs, Keogh plans have become less popular. For the most part, Keogh plans are less flexible and more expensive to establish and maintain. If you have employees, they must be included in your plan. For the vast majority of self-employed individuals, the other alternatives previously discussed are more appropriate.
Other options include Simple IRAs and Simple 401(k)s. However, they are not as attractive overall as solo 401(k)s and SEPs.
There are different deadlines for establishing retirement plans. For traditional IRAs, Roth IRAs and SEP IRAs, the deadline for establishing one is the due date of your return (generally April 15) plus any extensions requested, and Dec. 31 of the prior year for 401(k)s and Keogh plans.
IRS Publication 560 (Retirement Plans for Small Business) contains comprehensive tax information for these plans. An excellent source for information related to small business taxes is "Deduct It -- Lower Your Small Business Taxes" (Nolo Press), by Stephen Fishman.
Before you establish a plan, you should review your options with your tax adviser.
(Elliot Raphaelson welcomes your questions and comments at firstname.lastname@example.org.)