Retirement Plan Primer
 By R.K. Sparkman

You already understand the importance of having a retirement plan. But what are your choices as a self-employed entrepreneur, and how do plans differ?

Here’s a quick guide for considering retirement plans for your self-employed business. But do your homework before making a decision. And talk to your tax professional.

Of the many options for the self-employed, most plans are easy to setup and easy to maintain. Most plans reduce your immediate taxable income by deferring taxes until you withdraw the money, and provide tax-free growth on your invested funds.

Traditional IRA
The popular Individual Retirement Account (IRA) option allows your tax-deductible contribution to be any amount up to a maximum of $4,000 per year. Folks 50 and over can contribute up to $5,000. Withdrawals can be made at any time, but will be taxed. You’ll also pay a possible 10-percent penalty if you take a withdrawal before age 59˝.

Roth IRA
A Roth IRA’s major advantage is the ability for tax-free earnings and withdrawal. You also can contribute to a Roth IRA even if you contribute to a SEP, Solo 401(k) or Keogh.

The downside is that you don’t get a tax deduction when making contributions. If you would rather pay taxes on the money today than when you withdraw it in retirement, this plan is for you. Otherwise, it’s likely another of the approved plan options will suit you better. Contributions up to $4,000 are allowed. If you’re 50 or older, you can contribute up to $5,000 in 2006.

SIMPLE-IRA
A SIMPLE-IRA is a simplified method to make contributions, but only if your business maintains no other retirement plans.

For 2006, the maximum annual amount of contributions is $10,000. If you’re age 50 or older, the maximum annual amount is increased by $2,500. No special reporting to the government is required. Withdrawals are allowed at any time, but may be subject to a 25-percent penalty within the first two years of participation. There’s a possible 10-percent penalty if taken later.

SEP-IRA
A Simplified Employee Pension Plan (SEP) is designed specifically for the self-employed and small-business owners.

Tax-deductible contributions can be up to $42,000, or 25 percent of annual compensation. Contribution amounts can vary from year to year. Withdrawals are allowed at any time, but are taxable and subject to 10-percent penalty for those under age 59˝.

A SEP allows you to choose to contribute annually or only during profitable years. SEPs reduce taxes because all contributions are fully tax deductible as a business expense. SEPs are as easy to set up as an IRA, and require no IRS reporting or summary documents to file.

Keogh plans
Keogh plans are complicated and by comparison with the other options, expensive to set up and administer. The paperwork and reporting requirements are much greater than other plans.

Tax-deductible contributions up to 25 percent of self-employment income can be made, up to $42,000.

You must file an annual report, and costs of maintaining the program are relatively high. Keogh plans should be established with the help of accountants or tax lawyers. Keogh plans also prohibit withdrawal before retirement age, except in event of disability or other major events.

Solo 401(k)
A Solo 401(k) retirement plan may go by many names: Individual 401k, Personal(k), Self-Employed 401k, Uni-(k) or Solo(k). The plan is uniquely designed to benefit owner-only small businesses, the self-employed and independent contractors.

The Solo 401(k) is available to business owners who have no employees, other than a spouse. Sole proprietorships, partnerships and corporations also qualify. If you hire part-time employees, you may qualify and not be required to include them.

Contributions up to $42,000 a year are permitted ($4,000 more if 50 or older). The annual contributions include a tax-deductible salary deferral of $14,000 ($18,000 if age 50 or older) plus an additional tax-deductible profit sharing contribution of up to 25 percent of W-2 compensation for incorporated companies, or 20 percent of self-employment income for sole proprietorships. These amounts represent greater contributions at identical income levels compared to other plans.

Tax free loans are permitted for as much as 50 percent of total value with a $50,000 limit. Failure to repay the loan may result in a default, triggering taxes as well as IRS penalties.

AFS Members have access to a Solo 401(k) – and other retirement plans – through OppenheimerFunds. To find out more, click “Benefits” in the top toolbar and go to “Professional & Consulting” Benefits.


(Posted January 2006)

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