Self-Employment Pension Plans

  • Are you self-employed? Did you know you have many of the same options to save for retirement on a tax-deferred basis as employees participating in company plans? Here some highlights of your retirement plan options.

    Simplified Employee Pension (SEP)

    Contribute as much as 25% of your net earnings from self-employment (not including contributions for yourself), up to $53,000 (for 2015 and 2016). Set up the SEP plan for a year as late as the due date (including extensions) of your income tax return for that year.

    How Do These Responsibilities Affect The Operation Of The Plan?

    Simplified Employee Pension (SEP) plans can provide a significant source of income at retirement by allowing employers to set aside money in retirement accounts for themselves and their employees. A SEP does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee’s pay.

    • Available to any size business
    • No filing requirement for the employer
    • Only the employer contributes
    • To traditional IRAs (SEP-IRAs) set up for each eligible employee
    • Employee is always 100% vested in (or, has ownership of) all SEP-IRA money

    HOW DOES A SEP WORK?
    Jed works for the Rambling RV Company. Rambling RV decides to establish a SEP for its employees. Rambling RV has chosen a SEP because the RV industry is cyclical in nature, with good times and down times. In good years, Rambling RV can make larger contributions for its employees and in down times it can reduce the amount. Rambling RV’s contribution rate (whether large or small) must be uniform for all employees. The financial institution that Rambling RV has chosen for its SEP has several investment funds from which to choose. Jed decides to divide the contribution to his SEP-IRA among three of the available funds. Jed, an employee, cannot contribute because SEPs only permit employer contributions.

    PROS AND CONS:

    • Easy to set up and operate
    • Low administrative costs
    • Flexible annual contributions – good plan if cash flow is an issue
    • Employer must contribute equally for all eligible employees

    Who Contributes: Employer contributions only

    Contribution Limits: Total contributions to each employee’s SEP-IRA are limited.

    Filing Requirements: An employer generally has no filing requirements.

    Participant Loans: Not permitted. The assets may not be used as collateral.

    In-Service Withdrawals: Yes, but includible in income and subject to 10% additional tax if under age 59 1/2.

    Employee Contributions 401(k) plan

    Make salary deferrals up to $18,000 in 2015 and 2016 (plus an additional $6,000 if you're 50 or older) either on a pre-tax basis or as designated Roth contributions.

    Contribute up to an additional 25% of your net earnings from self-employment for total contributions of $53,000 for 2015 and 2016, including salary deferrals.

    Tailor your plan to allow access to your account balance through loans and hardship distributions.

    A one-participant 401(k) plan is sometimes referred to as a “solo-401(k),” “individual 401(k)” or “uni-401(k).” It is generally the same as other 401(k) plans, but because there are no employees other than your spouse who work for the business, it is exempt from discrimination testing.

    Savings Incentive Match Plan for Employees (SIMPLE IRA Plan)

    You can put all your net earnings from self-employment in the plan: up to $12,500 in 2015 and 2016 (plus an additional $3,000 if you're 50 or older) plus either a 2% fixed contribution or a 3% matching contribution.

    Set up a SIMPLE IRA plan at any time January 1 through October 1. If you became self-employed after October 1, you can set up a SIMPLE IRA plan for the year as soon as administratively feasible after your business starts.

    Choosing a Retirement Plan: SIMPLE IRA Plan

    SIMPLE IRA plans can provide a significant source of income at retirement by allowing employers and employees to set aside money in retirement accounts. SIMPLE IRA plans do not have the start-up and operating costs of a conventional retirement plan.

    • Available to any small business – generally with 100 or fewer employees
    • Employer cannot have any other retirement plan
    • No filing requirement for the employer

    Contributions:

    Employer is required to contribute each year either a:

    • Matching contribution up to 3% of compensation (not limited by the annual compensation limit), or
    • 2% nonelective contribution for each eligible employee
    • Under the “nonelective” contribution formula, even if an eligible employee doesn’t contribute to his or her SIMPLE IRA, that employee must still receive an employer contribution to his or her SIMPLE IRA equal to 2% of his or her compensation up to the annual limit of $255,000 for 2013 (subject to cost-of-living adjustments in later years)
    • Employees may elect to contribute
    • Employee is always 100% vested in (or, has ownership of) all SIMPLE IRA money

    How does a SIMPLE IRA plan work?

    Example 1:
    Elizabeth works for the Rockland Quarry Company, a small business with 50 employees. Rockland has decided to establish a SIMPLE IRA plan for its employees and will match its employees’ contributions dollar-for-dollar up to 3% of each employee’s compensation. Under this option, if a Rockland employee does not contribute to his or her SIMPLE IRA, then that employee does not receive any matching employer contribution.

    Elizabeth has a yearly compensation of $50,000 and contributes 5% of her compensation ($2,500) to her SIMPLE IRA. The Rockland matching contribution is $1,500 (3% of $50,000). Therefore, the total contribution to Elizabeth’s SIMPLE IRA that year is $4,000 (her $2,500 contribution plus Rockland’s $1,500 contribution). The financial institution holding Elizabeth’s SIMPLE IRA has several investment choices and she is free to choose which ones suit her best.

    Example 2:
    Austin works for the Skidmore Tire Company, a small business with 75 employees. Skidmore has a SIMPLE IRA plan for its employees and will make a 2% nonelective contribution for each of them. Under this option, even if a Skidmore employee does not contribute to his or her SIMPLE IRA, that employee would still receive an employer contribution to his or her SIMPLE IRA equal to 2% of compensation.

    Austin’s annual compensation is $40,000. Even if Austin does not contribute this year, Skidmore must still make a contribution of $800 (2% of $40,000).

    Pros and Cons:

    • Easy and inexpensive to set up and operate
    • Employees share responsibility for their retirement
    • No discrimination testing required
    • Inflexible contributions
    • Lower contribution limits than some other retirement plans

    Who Contributes: Employer must contribute and employee may contribute.

    Contribution Limits: Total contributions to each employee’s SIMPLE IRA are limited.

    Filing Requirements: An employer generally has no filing requirements.

    Participant Loans: Not permitted. The assets may not be used as collateral.

    In-Service Withdrawals: Yes, but includible in income and subject to a 10% additional tax if under age 59-1/2. Also, if withdrawals are made within the first two years of participation, the 10% additional tax is increased to 25%.

    OTHER DEFINED CONTRIBUTION PLANS

    Profit-Sharing Plan:

    Allows you to decide how much to contribute on an annual basis, up to 25% of compensation (not including contributions for yourself) or $53,000 for 2015 and 2016.

    Money Purchase Plan:

    Requires you to contribute a fixed percentage of your income every year, up to 25% of compensation (not including contributions for yourself), according to a formula stated in the plan.

    Defined benefit plans

    • Traditional pension plan with a stated annual benefit you will receive at retirement, usually based on salary and years of service.
    • Benefit may also be defined based on a cash balance formula in a hypothetical individual account (a cash balance plan).
    • Maximum annual benefit can be up to $215,000 for 2015 and 2016.
    • Contributions are calculated by an actuary based on the benefit you set and other factors (your age, expected returns on plan investments, etc.); no other annual contribution limit applies.

    What's a Keogh plan?

    Retirement plans for self-employed people were formerly referred to as “Keogh plans” after the law that first allowed unincorporated businesses to sponsor retirement plans. Since the law no longer distinguishes between corporate and other plan sponsors, the term is seldom used.

     

    Source: Internal Revenue Service (www.irs.org)