Choices abound for self-employed individuals
Thanks to several legislative changes over the years, self-employed individuals now have plenty of retirement plan choices on the table, just like the bigwigs in corporations, partnerships and limited liability companies (LLCs). Here are four popular items on the menu for self-employed individuals.
1. SEPs: Usually, a self-employed individual will adopt the IRA version of the Simplified Employee Pension (SEP), although a SEP-401(k) is a possible alternative. Any other employees must be covered. You generally contribute to the plan based on a percentage of compensation, up to the tax law limits, although annual contributions are not required. Deductible SEP contributions cannot exceed the lesser of 25% of the employee’s compensation or $53,000 in 2015. As with all qualified plans, the maximum compensation taken into account in 2015 is limited to $265,000.
2. SIMPLE: A Savings Incentive Match Plan for Employees (SIMPLE) is only available to a business with 100 or fewer employees and no other retirement plan. You must make a matching contribution equal to a certain portion or percentage of the employee’s contribution or a minimum nonelective contribution for all plan participants. As with SEPs, you can use an IRA or 401(k) version. For 2015, you can contribute up to $12,500 to a SIMPLE ($15,500 if age 50 or older). Bonus: You do not have to file an annual return for the plan.
3. Solo 401(k) plans: This plan may cover a business owner with no other employees (not counting your spouse). Generally, the rules and requirements for traditional 401(k) plans apply. For instance, a self-employed individual can defer up to $18,000 in 2015 ($24,000 if age 50 or older), while overall deductible contributions for this defined contribution plan, including matching contributions, cannot exceed the lesser of 25% of compensation or $53,000 ($59,000 if age 50 or older). Edge: Because the percentage part of the annual contribution limit does not apply to solo 401(k)s, this vehicle may be preferable to others.
4. Keogh plans: This “dinosaur” was initially designed to be the main qualified retirement plan for self-employed individuals, but it is still kicking around. There are two main types: defined-contribution Keoghs and defined-benefit Keoghs. The basic rules for these types of plans apply, but with a twist: The annual contribution limit is based on “earned income” instead of “compensation” and thus effectively reduces the percentage cap for self-employed individuals. In contrast with defined-contribution plans (see above), in 2015 a defined-benefit plan may provide an annual retirement benefit equal to the lesser of 100% of earned income for the three highest-paid years or $210,000.
In summary: When choosing a retirement plan option for yourself, be sure to investigate the possibilities. Then you can make a well-informed decision that is suitable for your situation.