Article
written by EricBank
If you are self-employed or a small business owner, now is a good time
to consider setting up a retirement plan. The three retirement plans discussed
here each has unique pros and cons, but each one will cut your tax bill and
provide other valuable benefits. All three work well for small businesses and
for the self-employed.
SIMPLE IRA
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is a good
choice for small businesses with no more than 100 employees, each of whom
received at least $5,000 in annual compensation. You can make matching
contributions up to 3 percent of a participant's compensation or non-elective
contributions of 2 percent of every employee's compensation up to $260,000.
Employees can contribute up to $12,000 ($14,500 for aged 50 and older). These
plans are easy and cheap to set up -- you file IRS Form 5304 -- and the plan
requires no administrator. This plan has higher limits than does an individual IRA
(although lower than other employer plan limits), and the employer
contributions are deductible. On the downside, SIMPLE IRA contributions reduce
allowable 401(k) contributions, and early withdrawals may trigger a 10 percent
penalty. You can only set up a SIMPLE IRA from January 1 through October 1.
SEP IRA
For a one- or two-person company, consider the Simplified Employee
Pension, or SEP IRA. This plan is easy to set up using IRS Form 5305-SEP. The
SEP accepts only employer contributions. The contribution limits are the lesser
of 25 percent of compensation or $52,000. This makes the SEP IRA attractive for
the self-employed, although the deduction for self-employed individuals
requires a special calculation. You must make contributions proportional to
each participant's compensation, but you can skip years. These plans must be
established by the end of the year to take a tax deduction in that year. They
are very simple and inexpensive to set up and run. Contributions don't affect
other accounts and you can terminate the plan any time. Possible disadvantages
include the fact that the contribution percentage must be the same for all
employees, employers contribute everything, and all employees must be included.
Individual 401(k)
The individual 401(k) applies to a self-employed person (and spouse).
These plans have the same rules as other 401(k) plans. As a self-employed
owner, you can make elective deferrals of 100 percent of your compensation up
to $17,500 in 2014. In addition, you can make employer nonelective
contributions up to 25 percent of your compensation. Total contributions for
2014 can't exceed $52,000 ($57,500 for owners age 50 or older). Once again, you
must make a special calculation to figure your maximum contribution. You must
open an individual 401(k) with a custodian by December 31 to take deductions in
the tax year, but you don't have to file a set-up form with the IRS. The
individual 401(k) is attractive because it allows you (and your
employee-spouse) to take deductible contributions in a flexible way, and you
can contribute up to April 15 for the prior year. However, these plans are
somewhat more complicated and expensive because you need a plan administrator,
and you must report plan assets annually with IRS Form 5500 once they exceed
$250,000.
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