NEW YORK (MainStreet) – Just because you own your own business or work for yourself doesn't mean you can't lean on the company for your retirement investments.
Business owners and the self-employed aren't completely adrift when it comes to retirement planning. Sure, they don't have an employee-offered 401(k) or a sweet matching program that gives them free money for a percentage of anything they put away. Whether you're a Schedule C tax-filing freelancer or an S corporation owner, there are a whole lot of ways to pocket large amounts of pretax cash without relinquishing your independence.
”When we're talking about self-employed individuals — including a lot of independent contractors that we see day in and day out or a business owner who works alone or in a husband-and-wife arrangement — there are some really efficient ways in which they can maximize their savings,” says Roman M. Kozak, vice president and senior retirement planning consultant at RBC Wealth Management. “The challenge is then 'How can we help that S corp owner or Schedule C sole-proprietorship filer maximize savings?'”
For many business owners and freelancers, the conversation begins with a SEP-IRA. Basically a simplified version of a profit-sharing plan, the SEP allows you to sock away a huge portion of your pretax earnings on an extremely liberal timetable.
“For many freelancers, a SEP-IRA is the easiest and most effective way of creating a flexible retirement plan that lets you defer up to $53,000 [for 2015] or 20% of your net earnings from self-employment, whichever is less,” says Ben Sullivan, certified financial planner and portfolio manager for Palisades Hudson Financial Group in Scarsdale, N.Y. “The great news is that entrepreneurs can still contribute to a SEP-IRA and reduce their tax liability for 2014, since a SEP-IRA can be established as late as your income tax filing deadline, including extensions.”
That's even better news, as Kozak notes the SEP-IRA lets contributors put away up to a quarter of their compensation for 2014 (but caps it $1,000 lower at $52,000). That's well more than the $18,000 that workers can contribute to a 401(k) in 2015. That doesn't mean it's for everybody.
“When considering which type of plan to set up, self-employed individuals should consider the amount of income they expect to earn over the next several years, the amount they want to contribute to the retirement plans, whether or not they will have employees and if they want to contribute to the employees’ retirement plans or allow the employees’ to fund their own plans,” Sullivan says. “It’s also important to consider the amount of complexity that you’re willing to deal with when administering a plan.”
If your income falls somewhat lower or you just want a few more options thrown in, there's always the aptly-named Simple IRA. As Kozak points out, its salary deferral feature for 2014 lets you to defer up to $12,000, or up to $14,500 if you're over age 50; then you can put in $14,500. On top of that, a self-employed worker or business owner can make either a matching a nonelective contribution.
“Most employers err on the side of matching, which allows them to match up to 3% of their income,” Kozak says. “If you're a business owner making $100,000, you can receive a $3,000 match that brings you up to $15,000 or $17,500 if you're over 50.”
The biggest downside to that particular plan is that you've already missed out on it for 2014. The deadline for opening a Simple IRA was Oct. 1 and the annual deadline typically falls around that same timeframe. The Simple IRA doesn't like a procrastinator.
“I'm a firm believer in pre-emptive efforts and a proactive approach to one's business and well-being," Kozak says. “We always talk about New Year's resolutions and being healthy and going back up to the health club: We should do the same thing as a business owner and review what last year looked like and look at what this year might look like.”
But if you've put yourself in a position where you have to wait anyway and have some more income to play with, you may as well go big. In 2002, the owner-only 401(k) profit-sharing plan debuted and became a huge hit with business owners. There are a few more moving parts to it and it's a bit more costly to maintain than a SEP-IRA or Simple IRA, but Kozak notes that the savings can be substantial.
In 2014, for a business owner making $100,000, the maximum pretax salary deferral was $17,500, or $23,000 for those over 50. In addition to that, however, there's an additional profit-sharing component that can contribute an additional 25% of an owner/worker's income, capping out at $52,000. For that same business owner making $100,000, that bumps the maximum contribution to $42,500, or $48,000 after age 50.
“Like other aspects of self-employment, saving for retirement requires more discipline for entrepreneurs than it does for employees,” Sullivan says. “The best retirement plan for an entrepreneur is specific to his or her circumstances, so it’s important to research your options and consult with an expert.”
— Written by Jason Notte for MainStreet