SAVING FOR RETIREMENT Do-It-Yourself Retirement Plans by Cameron Huddleston
When you work for a company with a retirement plan, setting aside money fore retirement is easy. You do a little paperwork and decide how much of your salary you can afford to defer each pay period. But when you're on your own, setting up a plan can be daunting. Besides having to choose among a growing menu of options for self-employed workers, you have to educate yourself about the rules and deal with all the administrative hassles.
To help you pick the right plan, here's a rundown of four retirement plans designed for the self-employed or owners of small firms and a table that compares contribution limits. Contributions for all the plans are tax-deductible and earnings are tax-deferred. You'll pay taxes and, usually, a 10% penalty on early withdrawals.
Individual 401(k)
Best for: A sole proprietor who wants to maximize contributions to a tax-deferred retirement plan. Limited to owner-only businesses, so it's not the best plan for small businesses with expansion plans.
Before changes to the tax law took effect in January 2002, the costs and paperwork associated with a 401(k) made it unwieldy for an owner-only business, and you could contribute only up to 15% of your compensation.
With the "individual(k)," the newest option in the do-it-yourself line of retirement plans, a sole proprietor can contribute up to 25% of compensation plus $14,000 in salary deferrals -- for a maximum contribution of $42,000. There's also a $4,000 catch-up contribution for those age 50 and older. Contributions are tax-deferred and tax-deductible. And you can take loans from your account just as you can with a traditional 401(k).
"It's a 401(k) that has been stripped of its complexities," says David Bergmann, a financial planner in Marina del Rey, Cal.
Because individual 401(k)s are relatively new, they're more expensive than some of your other options. Expect set-up and annual fees of up to $100 to $200. They are getting a little easier to find, and the 401khelpcenter.com has a list of financial firms now providing 401(k)s for sole proprietors.
You must establish your plan by December 31 and fund it by April 15. For a general idea of how much of a contribution you could make based on your compensation, use this calculator for a more precise amount.
SEP IRA
Best for: High-income business owners who want to maximize contributions through an uncomplicated plan with low fees. SEPs also work well for small-business owners with mostly low-paid, high-turnover employees, because there's no vesting structure and less incentive for employees to stay long-term.
With a simplified employee pension, or SEP, you can contribute 20% of compensation if you're unincorporated and 25% if you're incorporated, up to $42,000 annually. There's no additional salary deferral, so if your business is unincorporated, for example, your income must be at least $210,000 before you reach the $42,000 contribution level.
You can open and fund a SEP up until your tax filing deadline through a bank, brokerage or mutual fund company. It's easy to set up, and fees are relatively low (less than $100). With the exception of the higher contribution limits, SEPs are subject to the same rules as a regular IRA.
If you have employees, too, you make all the contributions. You must pony up the same percentage of compensation for your employees as for yourself, If you have lower paid employees, you can maximize contributions for yourself and minimize the cost of contributions for employees.
Keogh
Best for: Small-business owners who want to provide an incentive for key employees to stay with the firm. Because Keogh profit-sharing plans often have a vesting structure, the longer employees stay with a company, the more money they'll get.
There are two types of this defined-contribution plan: a profit-sharing plan and a money-purchase plan. Before changes in the tax law, the combination of these two plans offered the highest contribution limit. But now the contribution limit is the same as it is for SEPs and individual 401(k)s -- 25% of compensation, up to a $42,000 maximum.
The profit-sharing plan is flexible, allowing you set aside varying percentages of compensation from year to year. The money-sharing plan requires you to contribute the same percentage of income every year. Because people will no longer need the money-sharing plan to take advantage of high contribution limits, it likely will become extinct, says Robert Reby, a financial planner in Danbury, Conn.
Contributions are deductible and tax-deferred, but the paperwork can be complicated. Some sponsors hit you with a 10-page (or longer) application. Then you must file a Form 5500 with IRS each year if the plan covers anyone besides you and your spouse. You must open your account by December 31, but you have until April 15 to fund it.
SIMPLE IRA
Best for: Someone with self-employment income -- particularly from consulting or freelance work -- of $30,000 or less. There's no percentage-of-income limit, but actual dollar limits are much lower than for other plans.
A savings incentive match plan, or SIMPLE, allows you to defer up to $10,000 (or 100% of income, whichever is less) a year from your paycheck, plus 2% or 3% of income. For those age 50 and older, there is a $2,000 catch-up contribution.
If you earn $30,000, for example, you can contribute up to $8,900 a year if you take advantage of the 3% matching contribution. At that salary, the most you could set aside with a SEP or Keogh would be $7,500.
Firms with fewer than 100 employees can also use a SIMPLE. If you have employees, you must include them in your plan and match their contributions dollar for dollar up to 3% of compensation or contribute 2% of every employees' salary -- even for those who don't kick in money themselves.
You can have a SIMPLE even if you have a job that offers a pension plan, but you may not have both a SIMPLE and a Keogh. There are no special tax forms to file. You must open a SIMPLE by October 1 the year you make the contribution to get the deduction. Plans are offered by banks, brokerage firms and mutual funds.
GETTING STARTED
