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Retirement Plans For the Self-Employed

If the only pension fund you'll contribute to this year is an IRA, you may be missing out on better ways to save for retirement. Other plans -- including simplified employee pension (SEP), savings incentive match plan for employees (SIMPLE) and Keogh plans -- probably let you contribute much more money and take bigger deductions each year. In fact, as a self-employed person you have more options -- and an opportunity to shelter more savings from income tax -- than if you worked for someone else.

Although you may not be as familiar with these plans as you are with an IRA, don't let them intimidate you. They are fairly simple to set up and administer, even if you extend the benefits to your employees.

Which plan serves you best depends on several factors: your age, income, financial goals, tax bracket, family obligations and whether you want the plan to cover employees. Let's take a look at your alternatives and their benefits. But before you choose a plan, consult with your legal and financial advisors to make absolutely sure it's right for you.

Deduct and Defer

All the plans have at least two things in common. You can:

1. Deduct contributions, within limits, from your income for tax purposes, (with the exception of a Roth IRA), and
2. Defer tax (or avoid tax on a Roth IRA) on the income generated by the account until you take distributions, usually at retirement age.

The most important difference between the plans is their maximum allowable contributions and deductions. The maximum annual contribution and deduction amount for an IRA is $3,000 for 2002 ($6,000 for couples) through 2004. And beginning in 2002, anyone age 50 and over can contribute an extra $500. (For years beyond 2004, please call us for contribution limits.) The other plans let you contribute and deduct many times that amount. Call us for details.

SEP Plans

The plan least complicated and easiest to administer is the SEP. You can create one if you are self-employed and don't employ anyone else. You can set one up through almost any bank or other financial institution at low administrative costs. You can contribute to a SEP even if you participate in another employer's qualified retirement plan.

Annual contributions to a SEP are discretionary -- you don't have to contribute every year, and you can vary the amount from year to year, depending on your cash flow or other criteria. You can contribute and deduct a maximum of 13.0435% of your net self-employment income, but not more than $35,500 for 2002 (the amount is adjusted each year for inflation). Net self-employment income is defined as the total income from your business operations minus any deductions you're allowed to take for tax purposes. Those deductions include half your self-employment income tax payments and your deduction for contributions to your pension plan.

SIMPLEs

Employers with 100 or fewer qualified employees may set up a SIMPLE for employees. Employees can elect to contribute up to $7,000 in 2002. (Please call us for contribution limits for 2003 and beyond). The employer must either match contributions up to 3% of each worker's pay, or contribute a blanket 2% of each worker's pay -- even for workers who choose not to contribute.

Self-employed persons who have no employees can establish a SIMPLE also, with a maximum discretionary contribution of $7,000. You can set up the plan through a financial institution almost as easily as setting up a SEP.

Keogh Plans

Setting up and administering a Keogh is more complex and more expensive than the other plans. It usually requires the ongoing services of professional advisors. For example, you must file annual reports with the IRS when plan assets exceed $100,000. But you're allowed to make bigger deductible contributions to a Keogh.

You must choose between two types of Keogh plans: defined-contribution plans and defined-benefit plans. A defined-contribution plan limits the fixed annual contribution to the lesser of $40,000 or 100% of net self-employment earnings.

A defined-benefit plan is designed to yield a targeted annual retirement benefit, which can be as high as $160,000. Each year an actuary (for a fee, of course) calculates the actual contribution amount and determines how much more money you'll have to invest each year to reach your goal.

Contributions to some Keogh plans are not discretionary. Setting up the plan may lock you into contributing. That kind of commitment may be difficult for some self-employeds.

You can establish a Keogh without any employees. But if you have employees, you must give them an opportunity to participate, and you must make nondiscretionary (but deductible) contributions to their accounts. In some cases, participating employees may make additional, nondeductible contributions of their own.

Weigh the Benefits

You can find more information about these plans in IRS Publication 560, "Retirement Plans for Small Businesses." Call us for a copy and for help in weighing the benefits of each plan.

The most important difference between the plans is their maximum allowable contributions and deductions.

Comparison of Retirement Plans For the Self-Employed

1 Defined contribution plan
2 Defined benefit plan
3 Average taxable net business earnings from highest three consecutive years
4 Call us for applicable deductibility phase outs
5 For elective employer contributions, use a monthly schedule
6 If plan is subject to minimum funding requirements, you must make quarterly contributions