Self Employed Plans
Retirement Plan options for the Self Employed
You finally went out on your own and started a business. Nice! Since you no longer have access to an employer-sponsored retirement plan, how do you plan on saving for retirement? Before you pick a plan you should ask yourself these questions:
How much do you want to save in the plan each year?
Is it just me or do I have partners or employees?
Do I want the tax deduction now or would I rather have tax free money in retirement?
Do I just want to invest in stock market based products?
Here is a breakdown of the different "traditional" stock market-based plan options. For full disclosure, I am self-employed and currently, do not use any of these plans. I instead choose to invest in rental houses which you can learn more about in the rental real estate section.
SEP IRA - Simplified Employee Pension Plan
SEP IRA's are a nice option because there is very little paperwork involved in setting it up, you can contribute a large amount of money and they are flexible when it comes to contributions. It is funded completely by employer money (your money). A major thing to note is that the employer (you) needs to make contributions for everyone. So if you have three employees you have to contribute the same percentage of salary for all three. This might make it more attractive for sole proprietors or owner only businesses.
Money that you contribute to your SEP IRA is tax deductible similarly to a 401k or traditional IRA and can significantly reduce your taxable income. Contribution limits are a little confusing. There is a complicated calculation to determine your net income when it comes to the business owner. I am not going to get into the weeds, but here are the basics. You can contribute up to 25% of your net income (really comes out to about 20% after calculation) with a maximum amount of $55,000 per year for 2018. Here is a link to the IRS website if you would like to get more details, but the basic idea is if your net income is $150,000 you can sock away about $30,000 into your SEP IRA. Pretty cool.
You can open a SEP online at all the major players like Vanguard, Charles Schwab, TD Ameritrade, Betterment or Fidelity. Once you have it open you can decide how you would like to invest the funds. You can invest in stocks, bonds, mutual funds or ETF's. Just like with all stock-market-based retirement accounts I always favor investing in a diversified basket of very low-cost index funds.
SIMPLE IRA - Savings Incentive Match Plan for Employees
SIMPLE IRA's are a good plan for small employers where the owner wants to offer a retirement plan without going through the administrative hassle and cost of setting up a 401k plan. Each employee is set up with their own SIMPLE IRA account that works just like a traditional IRA.
The owner is required to make a contribution to each employees IRA account each year. The owner has two options for contributing. They can choose to offer a 3% matching contribution (which makes the employee have to contribute to get the match), or the employer can instead make a 2% involuntary contribution (each eligible employee gets this benefit even if they don't contribute)
The employee has the option of contributing through payroll deduction into their SIMPLE IRA account. An employee may defer up to $12,500 in 2018 while employees over 50 can contribute an additional $3,000 in "catch up" contributions.
Solo 401k Plan
Solo 401k plans are for a business with no employees. If that describes you, then these are a very good option. The owner of the business is able to act as both the employer (owner) and the employee when it comes to making contributions. So as the employee, you are able to contribute up to the normal 401k limits of $18,500 for 2018. ($24,500 if over 50 years old). You can also make employer non-elective contributions of up to 25% of compensation as defined by the plan. (usually results in 20% of self-employment income after IRS calculation) The maximum amount in total that can be contributed to your SOLO 401k plan for 2018 is $55,000.
Solo 401k plans can be a great way to go. You can contribute a good amount even with a small salary when compared to a SEP plan. You are also able to borrow against your account while you cannot in a SEP or SIMPLE plan. Another very nice feature is the Roth option where you can make after-tax contributions and then have tax free money in retirement. Your spouse can also participate in the Solo 401k plan as well. Personally, for me, this is what I will go with if I decide to start investing in retirement plans again in the future.