Do-It-Yourself Retirement Plans
Saturday, February 16, 2008; 12:00 AM
When you work for a company with a retirement plan, setting aside money for 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.
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 $15,500 in salary deferrals -- for a maximum contribution of $46,000. There's also a $5,000 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.
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.
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 $46,000 annually. There's no additional salary deferral, so if your business is unincorporated, for example, your income must be at least $230,000 before you reach the $46,000 contribution level.