Self employed? Plan for retirement
More than 9 million self-employed people are not covered by a retirement plan, according to the U.S. Small Business Administration.
Many of these people are business owners who may be hoping to retire on the profit they will make from selling their companies down the road, but they could be in for a disappointment if their plans don't pan out as expected.
The Minnesota Society of CPAs offers some perspective and explains some retirement savings options for the self-employed.
A reliable nest egg
Even if you are fairly close to retirement and believe that you have a pretty good idea of your company's value, changing economic conditions, new competition in your market or a host of other unknown factors can make it difficult to be sure what your business will be worth when you're ready to retire.
That's why CPAs advise self-employed business owners to set up a retirement account that will provide them with a reliable nest egg.
And there are many tax-advantaged options that can help maximize the value of your savings.
Sorting out SEP IRAs and SIMPLE IRAs
Many people are aware of two long-standing options for the self employed: SEP IRAs and SIMPLE IRAs. The Simplified Employee Pension (SEP) IRA is available to sole proprietors, partnerships and corporations.
If self-employed, you can contribute up to 20 percent of your net business profit each year, to a maximum of $49,000. (Net business profit is defined as the income of the business after expenses, and minus half of the self-employment tax.)
If incorporated, you can contribute the lesser of 25 percent of compensation, or $49,000.
SEP IRAs can be opened through a bank or other financial institution and are relatively easy to establish. You can make a contribution each year as late as the due date for your income tax return (including extensions).
In a Savings Incentive Match Plan for Employees (SIMPLE) IRA, you can set aside up to $11,500 of your self-employment earnings (plus another $2,500 if you're 50 or older).
SIMPLE IRAs are generally good options for small businesses with employees who want to avoid the often high costs of setting up and maintaining a traditional company retirement plan.
The employer is required to chip in either a contribution that matches up to 3 percent of employee compensation or a 2 percent contribution for each employee.
A third choice: Solo 401(k)s
There is another option, known as the solo or individual 401(k), open to business owners with no employees.
As an employee of the business, you are allowed to contribute up to 100 percent of your earned income, up to the annual contribution limit of $16,500, or $22,000 if you are age 50 or over, as long as those amounts don't exceed 100 percent of your salary.
As their own "employers," the self-employed can also contribute up to 20 percent of the net business profit, to a maximum of $49,000 or $54,500 if age 50 or over.
Tax advantages now or later?
Because you have several options, you can choose the type of tax advantages that work best for you.
With a SEP or SIMPLE IRA or what we'll call the traditional model of the solo 401(k), your initial contributions are deducted from your pretax income.
You do not pay taxes on that income now, but you do pay taxes on your withdrawals in retirement.
With a Roth solo 401(k), your current contributions are not deducted from your pretax income, but your withdrawals from the account upon retirement may be tax free.
With all these choices, the investment earnings on your contributions are tax free until retirement.