Self-Employed Retirement Plan Options
If you are self-employed or own a very small business with a few employees, you may enjoy the freedom and flexibility of being your own boss. But having the ability to set your own career path and call your own shots doesn’t mean that you can neglect your retirement. While it can be challenging to save for retirement while running a business, you should try to carve out some time to focus on achieving a sense of financial freedom. Fortunately, there are a few self-employed retirement plans that make it easy to save for retirement, including SEP-IRAs, SIMPLE IRAs, and more.
The seemingly small differences in these plans can have a big impact depending on your business and your unique needs. Take some time to compare the pros and cons as you try to find the right plan for you and your small business, and understand which is best for your retirement and tax situations.
A SEP-IRA (Simplified Employee Pension Individual Retirement Arrangement) allows employers to make retirement plan contributions to its employees. In addition, self-employed individuals may create and fund a SEP-IRA retirement plan for themselves. If you decide to establish a SEP IRA, you can contribute as much as 25 percent of your gross annual salary or 20 percent of your net adjusted annual self-employment income. SEP IRA contributions cannot exceed the maximum $54,000 in 2017.
Savings Incentive Match Plan for Employees (SIMPLE IRA)
SIMPLE stands for savings incentive match for employees. This is a plan that business with 100 employees or less can use. And compared to a traditional 401(k), the SIMPLE really is a simpler option... But only if you intend to match your employees' contributions. With a SIMPLE, employers must match employee contributions up to 3 percent of salary (if an employee doesn't make contributions, you still must contribute 2 percent of their salary). Contribution limits with a SIMPLE are lower than the limits allowed in a 401(k) plan. But for some business owners, the simplicity may be worth the difference. In 2017, the maximum amount employees can generally contribute to a SIMPLE IRA is $12,500. Employees age 50 or older are eligible for a $3,000 catch-up contribution.
Solo 401(k) Plan
A solo or individual(k) plan is a simplified version of a traditional 401(k) plan. If you are a solo business owner, meaning no other employees except maybe a spouse, a solo 401(k) is just that: your own personal 401(k) plan. The contribution limits are the same as the limits for a traditional 401(k), but because you administer the plan as well, you can match contributions as an employer up to 20 percent to 25 percent of salary. That means you can contribute almost double the traditional 401(k) limits in a solo 401(k). The maximum salary deferral contribution for 2017 is $18,000. If you are age 50 or older, you can contribute an additional $6,000 as a salary deferral catch-up contribution in 2017. The maximum profit sharing contribution is 25 percent of earned income, but total contributions (salary deferral plus profit sharing) to this plan cannot exceed $54,000 for 2017. You may also add the catch-up salary deferral contribution if you are eligible to make that. An individual Roth 401(k) plan option also exists providing business owners with the potential for tax-free growth of earnings.
Profit Sharing Plan
A profit sharing plan is a type of defined contribution plan that lets companies help employees save for retirement. With a profit sharing plan, contributions from the employer are discretionary. That means the company can decide from year to year how much to contribute (or whether to contribute at all) to an employee's plan. If the company does not have a profit, it does not have to make contributions to the plan. But a company does not need to be profitable to have a profit-sharing plan.
This flexibility makes it a great retirement plan option for small businesses or businesses of any size. In addition, profit sharing plans help align the financial well-being of employees to the company's success.
While there is no set amount that must be contributed to a profit-sharing plan each year, there is a maximum amount that can be contributed to a profit-sharing plan for each employee. The amount fluctuates over time with inflation. The maximum contribution amount for a profit sharing plan is the lesser of 100 percent of compensation or $54,000 in 2017. Additional, the amount of your compensation that can be taken into consideration when determining employer and employee contributions is limited. The compensation limitation is $270,000 in 2017.
Money Purchase Plan
A money purchase plan or money purchase pension is a type of defined contribution retirement plan offered by some employers. Money purchase plans are like other defined contribution plans, such as 401(k) and 403(b) plans, in that both the employer and employee make contributions to the plan. What makes money purchase plans different is that they require fixed employer contributions. That means that employers must contribute a fixed percentage of each eligible employee's salary annually to their retirement accounts.
Money purchase plans are similar to profit-sharing plans, but with a profit-sharing plan, the employer can determine each year how much will be distributed to employees. Instead of a fixed percentage of salary, a profit-sharing employer could decide to share a fixed amount of profit, and distribute it to employees each year as a percentage of salary. For employers, money purchase plans make budgeting and planning for contributions easier, while profit-sharing plans offer more flexibility in less profitable years.
Contributions made to money purchase plans are tax-deductible to the employer and tax-deferred for the employees. Investments grow tax-free until money is withdrawn in retirement.
There are limits to how much employees may contribute to a money purchase plan. The limits adjust over time with the cost of living. In 2017, contributions to money purchase plans are capped at 25 percent of the employee's salary or $54,000, whichever is less.
Keogh plans used to be the primary retirement savings option for the self-employed. But in the past decade, they've been overshadowed by SEPs, SIMPLE IRAs, and solo 401(k)s. In fact, the IRS no longer even refers to Keoghs, but the structure that supports them still exists. You can set up a Keogh like a pension or defined benefit plan, where you set an annual goal land fund it. The contribution limits are $215,000 in 2017, or 100 percent of compensation, which makes it attractive for professionals who make a lot of money and want to set aside a larger amount for retirement. You can also set it up like a defined contribution plan that works like a 401(k), with a limit of $54,000 in 2017. But the annual paperwork required to maintain a Keogh plan makes it a lot less attractive for most business owners.
Defined Benefit Plans
A defined benefit plan is a good choice if you are making a substantial amount of money and want to contribute a lot more than you are allowed to contribute to a SEP, SIMPLE IRA, or Individual(k) Plan. With this type of plan, you must have what is called a third-party administrator or actuary, who helps determined the amount and timing of your contributions.
The maximum contribution amount for a defined benefit plan is determined by your plan administrator based on a formula, so the maximum contribution will vary from person to person depending on the terms of your plan.
Contributions are required each year, and the contribution amount is usually substantial. This type of retirement plan is best for a self-employed person or business that has steady profits and wants to put away a large amount of money each year on a tax-deductible basis.
If you have or plan to bring on employees in the future, you will have to make contributions for them according to the terms outlined in your plan document. Generally, employees become eligible for contributions when they:
- Have worked more than 1,000 hours in the year
- Have worked for you more than one year (you can set this limit to two years if they are 100 percent vested in employer contributions once those contributions are made
- Are age 21 or older
For 2017, the most an employee may receive in annual benefits under a defined-benefit plan is the lesser of $215,000 or 100 percent of the largest average salary that they earned over a consecutive three-year period. (The much-higher limit for defined-benefit plans allows employers to fund a pension that may pay benefits for the remainder of the retired employee's life.)
Traditional or Roth IRAs
If you are seeking additional ways to save for retirement, the Individual Retirement Account is open to anyone with earned income (although Roth IRAs are subject to income limitations). Traditional or Roth IRAs can be used in combination with other plans, but keep in mind the amount of traditional IRA contributions you can deduct from your income taxes might be reduced. The IRA contribution limit in 2017 is $5,500 ($6,500 for ages 50 or older).
A small business does not have to mean small benefits. Special retirement plans let you prepare for a secure retirement at the same time you nurture your entrepreneurial spirit. For more information about the various retirement plans available for small businesses, see IRS Publication 560, Retirement Plans for Small Business or this list of Small Business Retirement Plan Resources.