How self-employed can save for retirement

Owning a business and being the boss can be a liberating way to make a living. You make the rules, you set the hours, and if you’re the only owner, you keep all the profits.

But being an entrepreneur also means you’re responsible for your own income. There’s no paycheck just for showing up; you have to bring the money in the door. That means no paid vacations. Nobody else is kicking in for your health insurance benefits, either. And you don’t have an employer-sponsored retirement plan to contribute to and have those contributions matched by your employer.

Many entrepreneurs find it difficult to save for retirement. Some years can be too lean to set aside extra money for tomorrow. And often the desire to reinvest profits into growing the business takes precedence over saving for retirement. Many self-employed people are counting on selling their businesses and using those funds for retirement.

Just because you don’t have the retirement options regular employees have doesn’t mean you as a business owner can’t save for retirement. There are several options for the self-employed, including those that offer many of the same tax advantages as employer-sponsored plans.

The most common plans are pretax plans, meaning the money you set aside is deducted from your taxable income. These include Solo 401(k)s, SEP IRAs, and SIMPLE IRAs.

Solo 401(k)

The Solo 401(k) or Individual 401(k) offers the highest contribution limits of the three main pretax plans for self-employed people.

This option allows you to take advantage of two contribution limits, one as an employer and one as an employee (As a self-employed person, the IRS considers you both). As the employer of your business, you can contribute 25 percent of the company’s net earnings, up to a maximum of $53,000 to the plan in 2015. In addition, as the company’s lone employee, you can also contribute an annual maximum of $18,000; $24,000 if you are 50 or older.

Setup requires completing paperwork with investment companies that offer these plans. Whereas the other two plan types can be set up in minutes, Solo 401(k)s typically require advance planning and research into the companies that offer them. You must set up a Solo 401(k) account by December 31, but you can contribute until April 15 of the following year.

Some of the flexible options allowed by Solo 401(k)s include:

You can set it up as a Roth 401(k) and make non-deductible contributions now and take tax-free withdrawals after retirement.

As with any 401(k), you are allowed to take loans from the plan provided the plan sponsor permits it.

Limitations of Solo 401(k)s include:

IRS contribution limits are per person, not per plan. This means if you also have a 401(k) with a traditional employer, the total employee contributions for both your employer and Solo 401(k) can only equal $18,000, or $24,000 if you are 50 or older.

They can only be used in businesses with no employees or in which spouses operate the businesses without employees.

Simplified Employee Pension (SEP)

SEPs are the most flexible self-employed retirement plan and the easiest to establish. Using this option is essentially like setting up an IRA for you and your employees.

For tax years 2015 and 2016, you can contribute 25 percent of your net earnings from self-employment – not including contributions for yourself – up to a maximum of $53,000.

To establish an SEP plan, just complete IRS Form 5305-SEP, or you can go through a bank or other financial institution.

Some of the flexible options allowed by SEPs include:

You can contribute to an SEP even if you have a traditional job, are covered by a workplace plan, but also have self-employed income. In fact, you can contribute the maximum to both an SEP for your business and a 401(k) from your employer during the same year.

You can fund the plan for the previous tax all the way until your business’s deadline to file your income tax return, including any extensions you have been granted.

There are no minimum contributions, so you can fund more into the plan when business is good and less when times are tight.

Limitations of SEPs include:

If you have employees, you must fund their retirement accounts at the same percentage as your own contribution.

Only you the employer can contribute to the plan. Employees cannot contribute to their own retirement plan.

SIMPLE IRA

As its name implies, the Savings Incentive Match Plan for Employees (SIMPLE) is more of a benefit to employees than a way for a self-employed person to save. But if you have less than 100 employees who don’t make large salaries, it’s a way to provide retirement savings for both you and them.

SIMPLE plans have the lowest contribution limit, $12,500 in 2015 and 2016 with an additional $3,000 allowed for individuals who are 50 and older.

One of the advantages over SEP plans is that employees can contribute up to the same maximum. The downside is that you the employer are required to contribute to your employees’ accounts; either a percentage match up to 3 percent of each employee’s salary or a flat 2 percent across the board.

Another limitation is that the IRS does not allow the business owner to have other simultaneous retirement plans.

Setting up a SIMPLE plan takes just a few minutes and can be done by filling out an IRS form and/or working with a bank or other financial institution. You must set up the plan by October 1 to contribute for that year.

Other options

In addition to the above-qualified plans, business owners have other options to save for retirement.

If you’re in the early stages of entrepreneurship, money’s tight and you just want to put something aside, you can set up a traditional IRA. You can contribute a maximum of $5,500 if you are under 50 and $6,500 if you’re 50 and older in 2015. The contribution is tax-deductible and can be made until April 15.

You can also opt for a Roth IRA, which won’t save you taxes on the contribution but allows tax-free withdrawals after you turn 59.

On the flip side, if you’re older and behind on retirement savings and want to put aside a large sum without contribution limits, you can consider an annuity. With an annuity, you pay the premium to an insurance company and the money in the contract grows tax-deferred. Once you decide to take income from the annuity, you can opt for lifetime income or an amount for a set period. You then pay tax on the income above what is considered a return of your premium. There are no IRS contribution limits to an annuity, so you can save as much as the insurance company will allow. You won’t, however, receive a tax deduction for that contribution.