No matter what your job, there should be a retirement plan available to you.
The United States Federal Government has instituted a number of systems to encourage retirement savings among its citizens. As life expectancy increases, the need for individuals to save for retirement is stronger than ever. In addition to the natural returns on investment that you will get from investing in good companies, retirement plans give added benefits such as tax exemption and sometimes even company matches.
While most people are familiar with 401Ks and company sponsored retirement plans which allow you to contribute pre-tax dollars from your paycheck, less people are aware of the variety of retirement systems that can be set up by individuals, small companies and the self-employed. In this article, we give a quick overview of some of the main options available to working US citizens.
Simplified Employee Pension (SEP) Plans
SEPs are simple, generic plans with low paperwork needs, and allow you to deduct up to 20% of your self-employment income, or up to 25% of your salary if you’re an employee of your own corporation. You are allowed to change the percentage annually, so if you have ups and downs in your business you won’t go bankrupt because you’re paying your own retirement plan. They can be opened as late as the extended due date of your income tax return, so you can do your taxes and then figure out how much you want to put in your SEP for maximum tax advantage. You can start one in minutes, generally free with no administrative expenses, with a bank, brokerage, or insurance company, and no annual government reports re required. They’re as easy as deductible IRAs but allow larger contributions.
Keogh, Profit Sharing, and Money Purchase Pension Plans
Keogh are less popular than when they were first introduced because of the heavy paperwork load involved. You can use profit-sharing plans or defined benefit pension plans, depending on how you want to leverage your business income. You do need to establish the plan before the end of the year, but you can defer contributions until the extended due date for that year’s tax return. The IRS requires an annual report, and you must have a plan document in the first year. Each year’s contribution must be calculated by an actuary, so your actuarial fees should be taxed onto the costs. And you must make the contribution defined by your actuary every year. Its primary advantage is that it permits larger contributions than any other type of program, making them great for older retirement planners.
Solo 401(k) plans
Solo 401(k) plans allow you to contribute more generously than other plans. You can contribute 100% of your first $15,000 ($20,000 if older than 50) of salary and then 25% (if compensated by company) or 20% (if sole proprietorship). The cap on the Solo 401(K) is $44,000 or $49,000 for those over 50. Solo 401(K)s require more paperwork than the other plans, so be advised.
Individual Retirement Accounts
An IRA makes a great additional retirement plan on top of any of the previously mentioned plans. The great thing about IRAs is that they are self-contained, flexible and not dependent on any particular company. You really have a lot of freedom to pick the best investment possible for your IRA. Also, the amount that you contribute to your IRA is independent of other retirement savings plans and thus doesn’t detract from the amount that you can contribute to them.
As you probably know, there are two types of IRAs. The first is called a Roth IRA where contributions are nondeductible, but earnings and other intraplan transactions are tax free; you have access to your contributions without penalty on demand, and eventually, when the IRA matures, you’ll be able to take out all your money without any federal tax liability.
If you think that you’ll be in a lower tax bracket after retirement than you are now, then consider a traditional IRA instead of the Roth. Keep in mind that IRA max contributions are the sum of both Roth and Traditional. In other words, if the max contribution is $4,000 then you would reach that max with $2,000 in a Roth and $2,000 in a Traditional.
Spousal Deductible IRAs are also available if your spouse contributes to a retirement plan at work. A Roth IRA is probably better in the long run, however, and a Spousal Deductible IRA is limited in many ways that can prove to be inconvenient.
If you have employees, the SEP, Solo 401(k) or Keogh must be available to them as well. In all 401(k) and Keogh plans, you’ll find some significant complications, and in all cases you’ll find limitations to how much you pay yourself in your retirement plan in relation to how much you pay your employees. An IRA does not come with any of these complications, but the total contribution amounts are much lower than the other plans. Regardless, if you have employees you should talk with an employee benefits professional before opening any kind of retirement plan for yourself.