After working for years at the automotive web site Carfax, Lowell Bike struck out on his own, co-founding MyAutoTips.com. Bike knew starting a business would have its challenges, but he never thought setting up a retirement plan would be so difficult.
“It was confusing,” he says. “There are just so many requirements for each different plan.”
As if saving for retirement wasn’t hard enough already, small business owners have the extra burden of having to set up their own savings funds. Business start-ups reached their highest level in 14 years in 2009, according to the Kauffman Index of Entrepreneurial Activity, and as more Americans become their own bosses, picking the right savings plan is an important planning decision.
But with different costs, advantages, and tax consequences to sort out – on top of the business you’re trying to run – setting up a self-employed retirement account can be tricky. The rewards are well worth it, says Eric Kuniholm, a principal at Boston-based Beacon Capital Management Advisors, which focuses on retirement planning for the self-employed. On top of retirement security, opening the account often results in “a significant and sometimes huge tax deduction,” he says.
Here are some of the major retirement plans for the self-employed – and some of the advantages and disadvantages of each. Keep in mind, in some of these choices, you’ll have to consider yourself both the saver and the employer, which can mean double-paying in some cases. But those plans are also ones you could offer to current or future employees.
Individual 401(k)
The individual 401(k), also known as a solo 401(k), works similarly to a 401(k) at a large company — and you can select between a Roth or a traditional plan. But it is only available for individual business owners and their spouses. The annual contribution limit for 2010 is ,500 — with the option of a profit-sharing add-on that is 25% of your compensation or ,000, whichever is less. The plan also offers ,500 annual catch-up contributions for savers 50 and older. These plans are now offered by most mutual fund and investment management companies.
Pros: This plan is flexible. There are no forced contributions, and sole proprietors can put away more money than they can with the SIMPLE IRA and often more than with the SEP IRA. Business owners can take out a loan from this plan.
Cons: The individual 401(k) is more costly – these plans usually range from about to 0 per year, though some can be even more expensive, Kuniholm says. They’re also more difficult to open and administer than some other options. And because costs vary greatly, savers need to shop around, says Jan Zobel, an Oakland-based enrolled agent and author of “Minding Her Own Business: The Self-Employed Woman’s Guide to Taxes and Recordkeeping.”
Best for: A solo businessperson who wants a higher cap for saving. “For most people, this plan will allow them to put more money away than they would be able to with the SEP,” Kuniholm says. Just be sure you’re up for the hassle of opening and operating the plan.
SEP IRA
The Simplified Employee Pension is basically a pension plan funded by the employer using a simple formula for contributions: In 2010, employers can contribute up to 20% of net self-employment income (or up to 25% of employees’ compensation) or ,000, whichever is less. Employers of any size are eligible for this plan.
Pros: The SEP is easy and inexpensive to start and administer, typically about – per year, Kuniholm says. It also has higher contribution limits than the SIMPLE IRA, and contribution amounts can vary each year, which allows for more flexibility. The SEP can be opened as late as the extended due date for your income taxes – until Oct. 15 for sole proprietors – and requires no annual government reports.
Cons: The sole responsibility of funding the SEP IRA falls on the employer, so if you have employees, you, as the employer, must contribute the same percentage of compensation for them as you do for yourself. Most people can save more with an individual 401(k) than with a SEP IRA. There’s no allowance for catch-up contributions. And you cannot take out a loan from this plan.
Best for: Because the burden of funding the plan falls solely on the employer, this is best for a one-person business or one with very few employees, says Wes Moss, CFP and chief investment strategist at Capital Investment Advisors in Atlanta. It works well for people who want to put away a fairly significant amount of money in an inexpensive and easy-to-maintain way — and have flexibility around their contribution levels.
