Retirement Plans for the Self-Employed

Personal IRA Choices for Individual and Small Business Owners

Nov 2, 2009

Standard individual retirement accounts or Roth IRAs are not self-employed business owners' only options. Qualified, tax-friendly plans offer higher contribution limits.

While self-employment brings tremendous risks and requires a great deal of effort, the benefits can also be tremendous. One such benefit is a wide array of retirement account options not available to most individuals who act as employees rather than self-employed individuals.

SIMPLE IRA is Mostly Employee-Funded

A 'Savings Incentive Match Plan for Employees' - or SIMPLE IRA - is primarily funded by the employee's earnings rather than employer funded. Up to $11,500 of an employee's earnings can be contributed as of 2009, or $13,000 for employees over 50 years of age. The only stipulation for self-employed individual is that no more can be contributed as an employee than is actually reported as profit on a Schedule C.

An employer is required to make a small contribution to a SIMPLE IRA in addition to the employee's contribution, though the amount is tiny - only between 1% and 3% of the employee's cearnings. For a maximum employee contribution of $11,500, this means the employer will be required to add no more than another $345 (3%).

One downside to a SIMPLE IRA is that the need to be established prior to October 1st in the fiscal accounting year, regardless of when taxes are required to be filed.

401(k) for Sole Proprietor

Similar to a corporate 401(k) plan, a single-participant 401(k) plan - or a solo 401(k) plan - is essentially the same offer with simplified paperwork. Of course, the plan participants are limited to the individual business owner and his or her spouse.

The maximum contribution an employee can make towards the plan as an employee is the lesser of $16,500 (as of 2009), and an additional $5500 for those over 50 years of age. As an employer, the business owner can contribute another 25% of compensation (or 20% of net earnings). The maximum contribution between the two, however can not exceed $49,000 as of 2009 (or $54,500 for those employees over 50).

A solo 401(k) needs to be established by December 31st of the calendar tax year to be funded that year. Contributions can be made, however, until the official tax filing is made.

What is a Keogh Plan?

Similar to a single-participant 401(k), the maximum contribution to a Keogh plan is the lesser of 25% of employee compensation, or $49,000 (for 2009, adjusted higher in some years). And, the plan must be established before December 31st of any fiscal tax year.

Unlike any other self-employment retirement account plan, there are actually two versions of a Keogh plan..... a defined benefit plan, or a defined contribution plan.

There is only one version of the defined benefit plan. Rather than defining an annual contribution limit, the defined benefit plan is funded with the intent to provide a specific monthly payout or cash value at a particular retirement age.... a relatively open-ended plan.

The nature of the plan clearly requires that the employer take on a significant risk after the employee retires. And, it clearly requires the employer plan and invest accordingly during the employee's working years.

High Tax Deferral With SEP IRA

A Simplifies Employee Pension Plan - or SEP for short - account can be established and funded up until the individual tax filing deadline (April 15th, barring an extension).

For self-employed persons, contributions can are capped at the lesser of 20% of the total net profit reported on Schedule C (or 25% of total compensation), or a flat limit amount established by the IRS. As of 2009, the maximum contribution one can make to a SEP IRA is $49,000, though the amount is frequently adjusted upward.

Contributions are not required; partial ones can be made at the employer's discretion as well. The only significant requirement regarding contributions is an employer must contribute equitably to all employees, including him or herself.