By FPA member Gil Armour, CFP®
Last Updated: June 27, 2011
If you have self-employment income, there is actually a wide variety of retirement plans that you can choose from for your tax-deferred savings.
Traditional Individual Retirement Account (IRA): Anyone with earned income can contribute to a Traditional IRA. The maximum annual contribution limit for 2011 is $5,000 ($6,000 for those who are age 50 and older). Depending on your gross income and whether you participate in an employer-sponsored retirement plan, the contribution may be deductible or non-deductible.
Roth IRA: The most appealing feature of this plan is that distributions may be 100 percent tax-free in retirement. Contribution limits are the same as for Traditional IRAs. However, based on your gross income, eligibility to contribute may be restricted. Single individuals with adjusted gross income (AGI) above $122,000 or joint filers with adjusted gross income above $179,000 are not eligible to make contributions. Partial contributions are permitted for singles with AGI between $107,000 and $122,000, and for joint filers with AGI between $169,000 and $179,000.
SIMPLE-IRA: The “Simplified Employee Pension for Employees” can be thought of as a simplified version of a 401(k) plan, without the administration and complexities of the latter. The participant may contribute up to $11,500 per year ($14,000 for those who are age 50 and older). Additionally, there is an employer contribution portion (self-employed individuals are both an employee and an employer of themselves) that permits another two or three percent of compensation to be contributed, depending on the particular option chosen.
SEP-IRA: The “Simplified Employee Pension” IRA can be thought of as a junior form of a profit sharing plan, without the administration and complexities of the latter. The annual contribution limit is 25 percent of net earnings from self-employment, up to a maximum of $49,000. Half of the self-employment tax and the SEP contribution itself are deducted from earnings in the calculation.
401(k): A 401(k) plan, normally thought of as a retirement plan for large employers, can actually be established for sole proprietors. Sometimes known as “uni-k” or “solo-k” plan, these allow the participant to contribute up to $49,000 ($54,000 for those who are age 50 and older) depending on net earnings. The total amount is comprised of an “employee” deferral portion up to $16,500 ($22,000 for those age 50 and older), plus an “employer” contribution up to 25 percent of net profits. These plans do involve more administration and cost than the simpler plans previously described.
Defined Benefit Plan: This is definitely the most complex of the plans discussed here. A defined benefit plan is particularly suited for those with high compensation who are nearing retirement age and wish to make hefty contributions to a plan for three or more years. Depending on age and income, contributions of as much as $195,000 may be allowed.
Depending on your level of self-employment income, your desired amount of retirement savings, and your tolerance for administration expenses, one or more of the above tools may be appropriate for you. Consider consulting with a tax adviser and/or financial planner to determine your optimum choice.
FPA member Gil Armour, CFP®, is a financial adviser with SagePoint Financial in San Diego, Calif.