by Lela Davidson
Retirement planning has come a long way. Thanks in part to the Baby Boomers, we seem to be bombarded with information and education about how to save for our golden years. But self-employed people need to do a little more research than their corporate contemporaries. When you work for someone else, planning for the future is simpler. A friendly HR professional hands you a stack of forms to populate with your preferred savings percentage and a limited array of investment options. It doesn’t take a financial mastermind to know that your best bet is to sock away as much as you can afford. The money magically disappears from your paycheck and until your nest egg has turned into a condo downtown.
Put Retirement on Your List
It’s nice when someone else does all the work, but retirement cannot be ignored. The effects of your decisions won’t hit you today or tomorrow, but will eventually accumulate – positive or negative. Don’t be intimidated. The reason things get complicated is that the tax laws are convoluted. As long as you know the basics, you have enough to begin an intelligent conversation with a financial professional. Don’t avoid these valuable savings options just because you don’t yet understand them.
SEP is short for Simplified Employee Pensions. These are also known as SEPs or SEP-IRAs. Simplified? I’ll say. A SEP is basically the same as IRA that you contribute to in order to get a tax deduction. The difference is that SEPs have larger contribution limits. Bigger deposits mean bigger deductions. With a SEP, you can contribute and deduct up to 20% of your net self-employment income, or $46,000, whichever is lower. The percentage jumps to 25% of your salary if you are an employee of your own corporation.
What’s the catch? If you have employees, you have to give them the same percentage you give yourself. And you can’t play favorites – everyone gets the same percentage. The saving grace is that it’s a percentage of income, so if business is not so good you’re not locked into giving big.
If you don’t have employees, this is a no-brainer. It’s easy to set up and there are no special tax forms to file. When you get paid, take your tax liability and set it aside. Then take 20% and put that away too. And if you hit the limit, take yourself out to celebrate!
A SIMPLE is closer to a traditional 401(k) plan, where employees are allowed to make salary deferrals. That means they can put pre-tax money into the plan. The business owner can also make contributions. For 2008, the salary deferral limits are $10,500 ($13,000 if older than age 50) and although there’s more to it, you can count on matching 3% percent of your employees’ salaries. Yes, matching employee contributions is required. If you have employees, a decent retirement plan can be crucial to attracting and retaining talent.
The popular 401(k) was originally designed for companies with 20 or more employees, but is now accessible to the self-employed individual with no employees other than a spouse. The difference between the self-employed 401(k) and the other plans is the potential for higher contributions. For 2008, the salary deferral limits are $15,500 ($20,500 if older than age 50). Total employer/employee contributions cannot exceed $46,000, or $50,000 if age 50 or older.
You will probably pay more in administrative costs on a self-employed 401(k), but the retirement savings may be worth it. Bear in mind that these are the basics. More sophisticated plans that will allow you to add profit sharing features, which can give your business a competitive advantage in recruiting good people.
Keep Your Earnings
I once had a client who was making over $100k working her small business. She was single and didn’t own a home. Talk about a taxation train wreck. She had never heard of any of these retirement vehicles! She lost many thousands to the IRS in a few short years.
Read up, talk to a professional financial planner, and trust your gut. If you can run your business, you can wrap your head around SEPs and IRAs. A decent CPA can be a wealth of information, but don’t you dare ask questions during tax season. Give them a couple more weeks! A certified financial planner or benefits consultant can also help you decide what kind of plan is best for your particular situation.
Then all you need is the discipline to fund your plan. How do you do it?