Three Retirement Plan Options For Self-Employed And Small Businesses Owners
If you are self-employed or a small business owner, now is a good time to consider setting up a retirement plan. The three retirement plans discussed here each has unique pros and cons, but each one will cut your tax bill and provide other valuable benefits. All three work well for small businesses and for the self-employed.
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is a good choice for small businesses with no more than 100 employees, each of whom received at least $5,000 in annual compensation. You can make matching contributions up to 3 percent of a participant’s compensation or non-elective contributions of 2 percent of every employee’s compensation up to $265,000. Employees can contribute up to $12,500 ($15,500 for aged 50 and older). These plans are easy and cheap to set up — you file IRS Form 5304 — and the plan requires no administrator. This plan has higher limits than does an individual IRA (although lower than other employer plan limits), and the employer contributions are deductible. On the downside, SIMPLE IRA contributions reduce allowable 401(k) contributions, and early withdrawals may trigger a 10 percent penalty. You can only set up a SIMPLE IRA from January 1 through October 1.
For a one- or two-person company, consider the Simplified Employee Pension, or SEP IRA. This plan is easy to set up using IRS Form 5305-SEP. The SEP accepts only employer contributions. The contribution limits are the lesser of 25 percent of compensation or $53,000. This makes the SEP IRA attractive for the self-employed, although the deduction for self-employed individuals requires a special calculation. You must make contributions proportional to each participant’s compensation, but you can skip years. These plans must be established by the end of the year to take a tax deduction in that year. They are very simple and inexpensive to set up and run. Contributions don’t affect other accounts and you can terminate the plan any time. Possible disadvantages include the fact that the contribution percentage must be the same for all employees, employers contribute everything, and all employees must be included.
The individual 401(k) applies to a self-employed person (and spouse). These plans have the same rules as other 401(k) plans. As a self-employed owner, you can make elective deferrals of 100 percent of your compensation up to $18,000 in 2016. In addition, you can make employer non-elective contributions up to 25 percent of your compensation. Total contributions for 2016 can’t exceed $53,000 ($59,000 for owners age 50 or older). Once again, you must make a special calculation to figure your maximum contribution. You must open an individual 401(k) with a custodian by December 31 to take deductions in the tax year, but you don’t have to file a set-up form with the IRS. The individual 401(k) is attractive because it allows you (and your employee-spouse) to take deductible contributions in a flexible way, and you can contribute up to April 15 for the prior year. However, these plans are somewhat more complicated and expensive because you need a plan administrator, and you must report plan assets annually with IRS Form 5500 once they exceed $250,000.