Saving for Retirement When You’re Self-Employed

Read the original article at Adaptu.

Whether you’re a small business owner with employees or just do a little freelancing on the side, you can contribute more to your retirement than the $5,000 a year maximum allowed through a traditional or Roth IRA.  If you’re looking to increase your total retirement savings, consider establishing a self-employed retirement plan—a SEP IRA, Simple IRA or a Solo 401(k). Each option is a little different, and the one that is best for you will depend on your income, goals and whether or not you have employees.


Who It’s Right For:

If you want to effortlessly save extra for retirement, a SEP IRA is probably the right account for you. They operate essentially the same as a traditional IRA, but with a much higher maximum contribution—25% of net adjusted self-employment income, up to $50,000 in 2012. They’re fairly easy to implement, having the least amount of paperwork and the lowest fees of all the retirement options, and the contribution calculation is the most straightforward of the bunch. Also, you do not have to contribute each year, which is a bonus for businesses with fluctuating income.

The Fine Print:

If you have employees who have worked for you for 3 of the past 5 years, are over the age of 21 and receive at least $550 in compensation, you will have to contribute to a SEP IRA on their behalf. The percentage contributed must be the same that you contribute for yourself, which can quickly add up. Calculating the allowable contribution amount can be a little tricky, so using an online calculator or consulting an accountant is advisable. Contributions for the year must be made by your tax-filing deadline.


Who It’s Right For:

For small business owners with fewer than 100 employees, SIMPLE IRAs allow for an easy, IRA-based retirement option that allows employees to make salary reduction contributions to their retirement savings. While similar to a 401(k), SIMPLE IRAs are much easier to establish and require less paperwork and administration.

The Fine Print:

Contribution limits are much lower for SIMPLE IRAs than for other retirement plan options. The total contribution allowed by an employee in 2012 is $11,500 ($14,000 for 50 and over). Employers are required to either match employee contributions, generally up to 3% of their compensation, or to make a non-elective 2% contribution for every employee. These amounts can be significantly less than the SEP IRA option, and with the ease of set–up and maintenance, SIMPLE IRA may be a good option for some small business owners.

Solo 401(k)

Who It’s Right For:

Solo 401(k)s have the same $50,000 contribution limit that SEP IRAs have, but combine both employer and employee contribution calculations. A self-employed person can contribute up to $17,000 in 2012 ($22,500 for those 50 and over) as the “employee” regardless of total compensation. Although, as with any retirement plan, the contribution must come from earned income, meaning you have to have made at least $17,000 to contribute that much. Additionally, a self-employed person may contribute up to 20% of net adjusted business profits as a profit-sharing contribution. The total contribution cannot exceed $50,000 in 2012, but the two different avenues of contributing can potentially result in higher total contributions than a SEP IRA, which may be appealing to self-employed people looking to contribute a sizeable percentage of their income to retirement. Another benefit of the Solo 401(k) is that it can be established as a Roth and funded with after-tax dollars, to secure tax-free withdrawals in retirement.

The Fine Print:

Solo 401(k)s are intended for businesses that do not have employees (other than a spouse). If you have part-time employees, you may be able to exclude them from participating, but you should consult a plan administrator to make sure. Solo 401(k) plans are much easier and less expensive than traditional 401(k) plans, but they do have more paperwork and fees than a SEP IRA.

If choosing which plan is best for you still seems daunting, try inputting your income into an online calculator to compare contribution limits, or consult your accountant for customized advice based on your situation. Although it may require some effort up front, you’ll be glad you took the time to prioritize your retirement sooner rather than later.

One Response to “Saving for Retirement When You’re Self-Employed”

  1. Nice article! helpful.


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