A Rundown of Self Employed Retirement Options

As I mentioned in my about section, part of my income comes as a self-employed contractor for tutoring high school students in Math and Science. I tutor through a company that pays me by the hour once a month without taxes. My income is reported in the form of a 1099-MISC. I am looking for a good self-employed retirement plan to shelter as much of my income from the IRS. Through internet searches, speaking with local banks and an accountant friend, I discovered my options were limited to a SEP (Simplified Employee Pension) IRA, SIMPLE (Savings Incentive Match Plan for Employees) IRA, Keogh Plan or solo 401k. Below is a rundown of the four options from the perspective of myself, an unincorporated self-employed contractor with no other employees.

SEP IRA

The SEP IRA is the simplest plan to setup and administer. Most financial institutions provide SEP accounts and are as easy to setup as a regular bank account. Additionally, a SEP account may be setup and funded anytime before the due date of the income tax return, including extensions. The maximum annual amount that I can fund is the lesser of 20% of net self-employment earnings or $46,000. The annual percentage invested is not fixed, which is good for self-employed contractors who don’t make fixed salaries.

SIMPLE IRA

Like the SEP IRA the SIMPLE IRA is easy to open, however, it must be opened prior to October 1st of the year the contribution will be made. The SIMPLE IRA limits the contributions to $10,500 for 2008. Due to this contribution limitation, the SIMPLE IRA doesn’t make sense for a self-employed contractor. The real advantages of a SIMPLE IRA come into play for small businesses as employees can defer a portion of their salary as a pre-tax contribution with possible employer matches.

Keogh Plan

Keogh plans come in two varieties: a profit-sharing plan or a defined benefit pension plan. The plan must be set up by the end of the year the contribution is for, however, the actual contribution may be invested anytime up until the due date of the tax return. For a profit-sharing plan the contribution may be 20% of self-employed income with a cap of $46,000. The profit-sharing plan requires a plan document and an annual report, which may cost a few bucks. With a defined benefit pension plan can contribute up to $185,000. The contribution is calculated by an actuary and it depends on income, target benefit, anticipated investment returns and years until retirement. There are fees and reports that can cost up to a thousand dollars.

Solo 401k

Solo 401k’s allow for contributions of 100% of your first $15,500. Additionally, you can contribute and deduct 20% of your total self-employed income. The solo 401k must be setup by the end of the year, however, contributions may be made up until the due date of the income tax return. The total salary deferral from a solo and traditional 401k must not exceed $15,500, however, I don’t participate in my companies’ 401k since they don’t match. A Form 5500 has to be filed once the account exceeds the value of $100,000. I have not experienced this yet (I will very soon), but the account setup typically goes through a brokerage and involves a set-up fee ($100ish) and an annual fee ($50-$250).

In summary, a SEP IRA is easy to open, especially last minute, however, I can only shelter 20% of my self-employed earnings, which leaves a large amount of my income taxable. SIMPLE IRA plans are easy to start and allow for a contribution of $10,800, however, it is more suited for a small business. A Keogh profit-sharing plan is similar to a SEP IRA in terms of contributions, but it is more time consuming to open. A Keogh defined benefit pension plan allows for a very large contribution, but is only attainable with extremely large incomes and minimal years until retirement.

For me the solo 401k is the best way to sock money away for retirement and shelter it from the IRS. In my first full year as a self-employed contractor I am estimating an income of $10,000. With a solo 401k I am able to shelter the entirety of my income, with the exception of 1/2 of the self-employment tax (I think, I will relay this info in a future post). With the SEP IRA and Keogh plan I am only able to shelter $2,000. The SIMPLE IRA will allow me to sock away all of my earnings this year, however, if I increase my self-employed income I will be limited to $10,800.

In my efforts to sock away as much as possible in tax sheltered retirement accounts, the solo 401k allows a max contribution in the present and future.

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