Hope for the Small Business Owner and the Self Employed!
Although small business owners and the self-employed do not have the same pensions that large companies and government employees enjoy, they have the ability to fund their own retirement accounts with options that can be tailored for their own personal needs. This flexibility allows them to create retirement accounts best suited for them and their employees in tax-favorable accounts designed especially for them.
Here are 4 of the most popular methods of personal retirement planning.
SIMPLE IRA
A SIMPLE IRA is just that -- pretty simple -- and the name is an acronym for Savings Incentive Match Plan for Employees. These plans are designed for small businesses with no more than 100 employees who earned $5,000 or more on the payroll for the previous calendar year.
Some advisers and tax professionals feel these plans are more suited for much smaller companies and typically recommend them for employers that have seven or fewer employees or for someone who is not making a lot of money and is looking to only put a modest amount into their retirement plan.
They are fairly easy and simple to set up. Including instructions, the account application is about four pages to fill out, and can be done in 10 minutes.
- Who can open one: Generally an employer with no more than 100 employees.
- Cost and complexity: Low.
- Employer contribution limit: 3 percent of employees' pay, matching, or 2 percent non-elective.
- Employee contribution limit: $11,500 for 2009.
- Annual reporting requirements: None.
SEP IRA
A SEP IRA, or Simplified Employee Pension plan, is as easy and low cost to set up and maintain as the SIMPLE IRA. But instead of the employee making contributions to the plan with a match from the employer, the employer makes the entire contribution.
Self-employed workers may find the SEP ideal due to its low setup and maintenance costs. Business owners can save quite a bit more in a SEP than the SIMPLE or other IRAs. For 2009, the contribution limit is 25 percent of net income up to $49,000.
For these plans, keep in mind that understanding the difference between net and gross income is very important for self-employed workers when it comes to figuring their retirement contributions. Gross income minus expenses equals net income.
As an example, say you receive $5,000 for a product, but you spent $1,000 on supplies and Web advertising to make that sale. That $1,000 subtracted from the $5,000 gives you $4,000 net. The net income is what your pension contribution is based on.
- Who can open one: Any employer or self-employed person.
- Cost and complexity: Low.
- Employer contribution limit: 25 percent of employees' net income up to $49,000.
- Employee contribution limit: Not applicable.
- Annual reporting requirements: None.
Solo 401(k)
Similar to a 401(k) used at companies across the country, a Solo 401(k) lets small-business owners share the fun and benefits. The business must be very small and limited solely to the owners of the business and their spouses.
The Solo 401(k) allows business owners to put away more money than a SIMPLE or SEP IRA and there is flexibility when it comes to contributions. You can contribute more or less every year, but a maximum of $16,500 for 2009.
A profit sharing component can also be added to a Solo-K to allow maximize contributions be made to the plan. The employer can make a maximum tax-deductible contribution to the plan of up to 25 percent of compensation, within allowable limits.
- Who can open one: Self-employed business owners with no employees other than a spouse.
- Cost and complexity: Medium.
- Employer contribution limit: $16,500 of salary deferral plus 25 percent of compensation, or $49,000, whichever is less, if a profit sharing component is added to the plan.
- Employee contribution limit: Not applicable.
- Annual reporting requirements: Yes.
Defined Benefit Plan
The most expensive and complicated retirement plan for the self-employed and similar to a traditional pension plan. The defined benefit plan is most appropriate for someone with a mountain of money to save for retirement.
Employers can save a maximum of $195,000 per year but will need an actuary to determine the amount that can be contributed, which adds to the cost of the plan.
Although a defined benefit plan will give you your largest contributions, in addition to the need for an actuary, you will need a plan document making this type of retirement plan the most expensive to do and will require you to make a contribution every year.
In contrast, the Solo-K, SEP and SIMPLE IRAs allow more flexibility by allowing employers to reduce contributions in a year with poor cash flow.
Due to their expense and complexity, defined benefit plans, just like the traditional company pension plans, are pretty much outmoded. According to the Pension Benefit Guaranty Corp., there are 38,000 defined benefit plans today compared to 114,000 in 1985. Despite their waning popularity, they can still be a good option for business owners who want to save the most money on a tax-deferred basis as possible.
- Who can open one: Any employer of any size.
- Cost and complexity: High.
- Employer contribution limit: Up to $195,000, but the actual amount is determined by a formula used to calculate the benefit an employee earns for retirement. An actuary determines the amount to be contributed to the plan.
- Employee contribution limit: Not applicable.
- Annual reporting requirements: Yes.
