All you have to do is Google the phrase "retirement planning" and a plentitude of websites will appear--more than 1.8 million. However, when it comes to planning for the self-employed, it's important to focus on the specifics that distinguish business owners from employees.
Business owners generally have control over the type of plan that's chosen, while employees basically have to determine whether they will or won't contribute to the plan their company has in place. With that in mind, I have outlined three of the most common self-employed retirement plans, along with some key features and 2007 contribution limits.
Simplified employee pensions--also known as SEPs or SEP-IRAs--are the most basic and easiest-to-understand retirement plans. They're akin to deductible IRAs in that you get a tax deduction for your contribution. However, the big advantage is that SEPs have larger contribution limits.
SEPs allow you to contribute and deduct up to 20 percent of your net self-employment income; the limit is 25 percent of your salary if you're an employee of your own corporation. Keep in mind that since your self-employment income may vary each year, the contribution can vary as well. So, in lean years, lower amounts--or nothing at all--can be contributed. Also, if you have employees, you, as the employer, must contribute the same percentage of salary on their behalf. For 2007, the maximum contribution is $45,000.
Operationally, SEPs are low cost and low maintenance. The paperwork required is as basic as a brokerage account application. There are no annual forms or other reports to file with the IRS. Plus, they can be established as late as the income tax filing deadline plus extensions--April 15 for most people.
If you have employees and want them to contribute to their retirement plans, then a SIMPLE might work for you. Like the SEP, the SIMPLE allows for tax-deductible contributions on behalf of the business owner. However, the SIMPLE also allows employees--including the business owner--to make salary deferrals.
For 2007, the salary deferral limits are $10,500 and $13,000 if older than age 50. The employer match is mandatory and is based on one of two options: match employee contributions up to 3 percent of salary, whereby this 3 percent match can be reduced to 1 percent in two out of five years; or contribute 2 percent of each employee's compensation, up to $4,500.
Operationally, the application for the SIMPLE is as easy as a brokerage account. However, there is a bit more record keeping involved, since contributions come from both salary deferrals and employer contributions. Expect to pay a bit more in annual maintenance fees for a SIMPLE than a SEP. Note that the deadline to open a SIMPLE is October 1.
Originally designed for companies with 20 or more employees, the popular 401(k) is now accessible to the self-employed individual with no employees other than a spouse. This plan potentially allows for a higher contribution limit than the SEP and is funded by both employer contributions and employee salary deferrals.
For 2007, the salary deferral limits are $15,500 and $20,500 if older than age 50. The employer contribution can be up to 25 percent of compensation, with a maximum of $45,000. Total employer/employee contributions cannot exceed $45,000; $50,000 if age 50 or older.
Operationally, the self-employed 401(k) is a bit high maintenance in that once plan assets reach $100,000 a special tax form--Form 5500--has to be filed annually with the IRS. These plans must be established by December 31 or by the end of the company's fiscal year.
While these three plans are the most straightforward, there are other more sophisticated plans that allow you to add profit sharing features. Deciding on which plan makes sense for you depends on a number of factors, including the overall cost to you as the business owner, the number of employees, your age, how close you are to retirement, your employees' ages, and how much you want to contribute on behalf of yourself and your employees.
I strongly recommend that you consult with a certified financial planner or benefits consultant to crunch the numbers and determine which plan makes the most sense for you and your business.
Debra Neiman, CFP, is and principal of Neiman & Associates Financial Services, a financial planning firm and registered investment advisor in Watertown, Massachusetts. She's also the co-author of the recently released book, Money Without Matrimony: The Unmarried Couple's Guide to Financial Security.