There are many perks to working for yourself: No long, useless department meetings and you can leave whatever time you want.
Of course the downside is there's no one to gossip with at the water cooler and you're on your own for retirement.
Thankfully, there are plenty of retirement savings options these days. So if you don't have a plan established yet, get on it. And if you already set up a plan years ago, you may be ready for a change, thanks to some new options. Most plans have to be established by year-end to count for 2005, but there is one option that needs to be in place by Oct. 1.
The plan of your choice will ultimately be determined by how much you can save. So think about how much you can afford to sock away each year, then read on to decide which plan best fits your needs.
Defined Benefit Plan
If you've been a retirement-saving slacker and now have the ability to save large chunks, a defined benefit plan may be the perfect choice for you.
As long as you're at least 10 years away from retirement, you have the opportunity to make up for lost time. At this point, the tax code allows withdrawals of $170,000 a year from a defined benefit plan, says Dick O'Donnell, a tax analyst at RIA, a Thomson business providing informationand software to tax professionals. So your goal should be to put enough money away now so that you can withdraw $170,000 in retirement. (Granted, that $170,000 amount might change by the time you retire, but it's a guideline for now.)
You'll need to sit down with an actuary to determine how much you should contribute to the plan now to hit that goal in retirement. And the upside is you'll get a deduction for your full contribution, says Bart Fooden, president of his own firm and a member of the NYSCCPA Estate Planning and Tax Committees. For instance, if it's actuarially determined that you need to put $200,000 away a year to meet your goal, then you'll get a deduction for $200,000.
Of course, you'll owe taxes on the money when you start to withdraw at retirement. The bigger issue, however, is that you need to commit. Once your actuary determines how much you need to put awayeach year, it's written in stone. For example, if you agree to put $50,000 in your plan each year but in 2007, your business has a bad year, you still have to come up with the contribution amount or the IRS will penalize you, says Fooden.
If before year-end you realize that you're never going to make your contribution number, you can file paperwork with the IRS and ask to have the plan suspended for the year. As long as that's all done by Dec. 31, you'll be excused from making your contribution to the plan.
So while it's a great option for someone who hasn't started to save much yet and can now afford to, it could be an administrative headache if you don't consistently have the money.
If you think a defined benefit plan could work for you,
Uni-DB is a good place to start your investigation.
If you're afraid of commitment, as many of us are, the solo 401(k) plan might be a better solution. It resembles corporate America's 401(k) except that you can contribute more money.
Your total contribution to a solo 401(k), a.k.a. self-employed 401(k), can't exceed $42,000 for 2005 ($46,000 for people age 50 and over). That's a big difference from the corporate folks, whose max for 2005 is $14,000 ($18,000 for the 50 and up crowd).
Here's why. As a self-employed person, you can have $14,000 withheld from your paycheck, just like any other employee. But then, as the employer of a self-employed business, you can contribute another 20% of your net self-employed income. For instance, if you make $140,000, you can contribute another $28,000 to the solo 401(k) plan. That would bring you to the total $42,000 for the year.
The total contribution can't exceed $42,000 for 2005 and the plan must be established by Dec. 31 to qualify for this year, reminds O'Donnell.
In addition, there are no set-up or annual maintenance fees. The only drawback is that once your plan's assets exceed $100,000, you'll have to file a Form 5500, Annual Return/Report of Employee Benefit Plan, with the IRS. And just like any other 401(k), you can't withdraw the money before reaching 59-and-a-half without a penalty.
The World of IRAs
If you're thinking you'll never have an extra $42,000 to stash away, consider an IRA for now. There are two basic choices for self-employed folks.
If it's just you or you have a few employees, the SEP-IRA or Simplified Employee Pension could work. You can contribute up to 20% of your net earnings to a maximum of $42,000. So that could mean a potential $42,000 deduction on your business tax return, if you had the money.
And this IRA doesn't have to be established until the time your file your tax return -- including extensions. So if you put your 2004 tax return on extension again and it's now due on Oct. 15, you could still set up a SEP-IRA for 2004 and make a qualifying contribution.
There are no real administrative responsibilities here, but remember that you'll get hit with a 10% penalty if you try to withdraw the money before age 59-and-a-half.
But run the numbers because you may still be better off with a solo 401(k). Let's say your net earnings are around $75,000 a year. With a SEP-IRA, your deductible contribution will max out at 20%, or $15,000. But with the solo 401(k), you can first defer the $14,000, then contribute the 20%, or $15,000, on top of that.
So you just put away $29,000 with the solo 401(k) vs. $15,000 with the SEP-IRA. "If you have the money, it makes no sense to have an IRA, you might as well do a solo 401(k)," says Fooden.
And for those of you who are over 50, keep in mind you don't get a catch-up provision with a SEP-IRA. With the solo 401(k), you can tack on another $4,000 to your $14,000 deferral.
If you have 100 or fewer employees, you may consider a Simple IRA, which is basically the same as a SEP-IRA except your contribution is capped at $10,000 ($12,000 for people 50 and over). If you're on your own now and anticipate adding employees to the payroll in the near future,this may be a good option.
In addition, if you don't make a ton of money but are able to sock most of your profits away, the Simple IRA could be a good choice. Let's say your business only makes $20,000 but you can afford to save $10,000. With the Simple IRA, you can. If instead you had a SEP-IRA, you'd only be able to contribute 20% of that $20,000, or $4,000, notes Fooden.
Big note: Your Simple-IRA plan must be up and running by Oct. 1 of the current tax year to qualify.
If you're just getting your company off the ground, an IRA may be a good place to start. And know that you can always roll an IRA into a solo 401(k) down the road when your business starts to boom.
Smith Barney unit,
T. Rowe Price
( SCH), or any other broker, and start saving. Pick a plan and put money away monthly. And then think about how great it will be when you finally pass on the business
to your kids, and retire to your dream house in style.