Retirement Plans for Self-Employed/Small Business Owner
By Kristi Vaughan
Being self-employed or owning a small business can have lots of advantages ... autonomy, flexible hours, and the potential for high earnings, among them. But what about financial security in retirement? How will you fund your retirement if you are self-employed? How will you help with the retirement of your employees?
You Have Many Options
As the number of self-employed individuals and entrepreneurs has grown in recent years, so have the options for tax-favored retirement savings plans.
There are three basic retirement vehicles: Individual Retirement Arrangements (IRAs); defined contribution plans and defined benefit plans. Your financial advisor can help you determine the one that is right for you and your business
IRA-based plans
Among the simplest retirement plans to establish are the Individual Retirement Arrangement-based plans. The federal Internal Revenue Service details four types of IRA-based plans:
- Payroll deduction IRA. Employers can help eligible employees save for retirement by establishing a payroll deduction plan. To establish a traditional IRA or a Roth IRA employees must meet income and earnings qualifications.
- The Salary Reduction Simplified Employee Pension Plan (SARSEP). SARSEP plans must have been established by 1996. This plan allows employees to defer part of their salaries. At least 50 percent of employees must make deferrals for the year
- The Simplified Employee Pension (SEP IRA) plan can be used by businesses of any size, including self-employed sole proprietorships. The plan is funded by employer contributions into traditional IRAs. There is a maximum that can be contributed each year and employees below the age of 21 or earning less than $450 for the year are not eligible.
- The Savings Incentive Match Plan for Employees (SIMPLE) IRA plan allows employers and employees to contribute to a retirement plan. Employers can match employee contributions up to 3 percent of pay or make a 2 percent non-elective contribution for each employee, whether the employee is participating in the plan or not.
Defined Contribution Plans
Defined contribution plans are established by employers and can include contributions from employees as well as the employer. Defined contribution plans do not promise a specific retirement benefit. Such plans include:
- 401(k): 401 (k) plans are the most popular of the retirement plans. They permit the highest level of salary deferral by employees with a limit of up to $15,000 by 2006. Employers can match contributions up to preset limits.
- Keogh plans: Keogh plans can be defined contribution or defined benefit. They are more complicated to set up than IRA-based plans.
Defined Benefit Plans
Defined benefit plans promise a specific benefit at retirement. These plans are often employer-funded with no contribution from the employee.
