5 Retirement Plans for the Self-Employed

Self employment means that one is responsible for setting up and maintaining one’s own retirement plan. If this is neglected, the financial future of the self employed person may be in trouble. Besides the obvious problem of not having enough money to be comfortable at retirement time, setting up a retirement plan can provide significant tax savings, either now or in the future.

Here are some of the available retirement plans and their benefits and drawbacks for the self employed person.

401(k) Retirement Plans

A solo 401(k) can be established for the self employed, although 401(k) plans were designed for an employer to implement. Choosing a 401(k) can mean more expense than other plans in setting up and maintaining the plan.

Individual Retirement Accounts (IRA’s)

Another plan that was not meant for the self employed but can still work is an Individual Retirement Account (IRA). The most common types of IRA’s are Roth and the traditional type. The biggest advantage to either a Roth or traditional IRA is in taxes.

Using a Roth IRA, an individual pays taxes on earnings, then makes the retirement payment and there are no further taxes due when it’s time to receive distributions at retirement. Although there are other rules and regulations, usually if a self employed person thinks he will be in a higher tax bracket when retirement comes, then a Roth IRA is the right decision.

Traditional IRA’s are paid into before taxes are made on earnings and will not be taxed until retirement distribution. This works out very well if the tax payer thinks he will be in a lower tax bracket at retirement, thus paying less tax on the same amount of money.

SIMPLE Retirement Plans

SIMPLE stands for Savings Incentive Match Plan for Employess or Small Employers. In reality, a SIMPLE plan is an IRA, but it was created specifically for small businesses. Again, it can be used by self employeed individuals if they’re sole proprietors.

A SIMPLE plan is easy to establish and inexpensive to maintain. It’s a commonly offered plan by many financial institutions and it has lower contribution limits than other available IRA plans.

SEP Retirement Plans

A retirement plan written for self employed persons and small business owners, an SEP is also a type of IRA plan, much on the order of the SIMPLE plan. LLC’s, sole proprietorships and S and C corporations all qualify for this retirement plan.

As a rule, contributions to a SEP IRA are completely tax deductible, with even investment earnings only taxed at withdrawal. Contributions are made before taxes are paid. If a withdrawal is made from an SEP plan before 59 1/2 a 10% penalty may be charged by the IRS, in addition to income tax on the amount. Withdrawals after 59 1/2 years of age will be taxed at the rate of ordinary income.

SEP IRA’s have great benefits in that there is minimal administration involved and annual contribution limits are high, but with no requirement to contribute amy certain amount. If the income fluctuates somewhat from year to year, a self employed person has the freedom to adjust contributions accordingly, allowing the fund to grow quickly at times and more slowly when income is lower.

Keogh Retirement Plans

This plan was written especially for self employed persons. It can be structured two ways: As a defined benefit plan and as a defined contribution plan. A defined benefit plan is similar to a pension plan, while a defined contribution plan is similar to a 401(k).

Since Keogh plans are not as common as other plans the self employed can use because they’re harder to set up and expensive to maintain.