THERE'S MORE to being your own boss than not having to answer to anybody: You can also set up your own tax-advantaged retirement program -- and probably put aside more each year than you could working for somebody else.
Until relatively recently, SEPs and Keoghs were the only recommended varieties of qualified retirement plans for self-employed folks. And don't get us wrong -- both are great tax shelters. You get a current deduction for your contribution plus you get compounded tax-deferred growth -- there's no tax on earnings until you start drawing down the account. But now, on top of these time-honored qualified plans, you also have the Roth IRA as an option, which provides an excellent supplemental tax break.
Here's what you need to know to squeeze the most out of these self-employed retirement plan options.
SEPs -- Simple and Good
Simplified employee pensions -- referred to as SEPs or SEP-IRAs -- are generic retirement plans that allow you to contribute and deduct up to 13.04% of self-employment income (15% of salary if you're an employee of your own corporation). For 2002, the maximum annual contribution is $30,000 ($25,500 in 2001). However, the percentage can be varied each year, so lower amounts (or nothing at all) can be contributed when you turn out to be starved for cash.
SEPs are great for procrastinators because they can be opened up as late as the extended due date of your income tax return. Finally, SEPs are much simpler to establish and administer than Keogh profit-sharing and pension plans. It literally takes only minutes to get one started -- usually with no charge -- with a bank, brokerage firm or insurance company. No annual government reports are required, and ongoing administrative expenses are nil. The bottom line is SEPs are just as easy as deductible IRAs, but they allow much bigger contributions.
| SELF-EMPLOYMENT RETIREMENT PLANS |
| PLAN |
CONTRIBUTION LIMITS |
PHASEOUT LIMITS |
COMMENTS |
| SEP |
15%**/$30,000 |
None |
Simple to establish and administer |
| Keogh |
25%/$40,000 (or more) |
None |
Can be designated a profit-sharing plan or a defined benefit plan. Generally requires a professional to set up, especially if you want a defined benefit plan. |
| Roth IRAs |
$3,000 for singles, $6,000 for couples |
$95,000-110,000 for singles, $150,000-160,000 for joint filers |
Contributions are nondeductible, but earnings grow tax-free. |
| Spousal Deductible IRA |
$3,000 |
$150,000-160,000 |
Now, if you are covered by a retirement plan, but your spouse isn't, he or she can make a $3,000 deductible contribution to an IRA, as long as your joint AGI is under $150,000. |
*Based on 2002 limits
**13.04% of self-employed income or 15% of compensation for employees. |
Keogh Plans
Keogh plans are the self-employed equivalent of corporate retirement programs. They come in two basic flavors: profit-sharing plans and defined-benefit pension plans. To get a deduction for the current tax year, the plan must be established before year's end. Once that's done, actual contributions can be deferred until the extended due date for that year's return.
Annual contributions to Keogh profit-sharing plans are based on a percentage of self-employment income (up to 20% vs. 15% for SEPs) subject to a $40,000 ceiling ($35,000 in 2001). Lower percentages are OK, too. A plan document must be drafted in Year One (this may cost a couple hundred bucks), and the IRS demands an annual report (you can probably do this yourself).
Keogh defined-benefit pension plans are designed to deliver a targeted annual retirement benefit, which can be as high as $160,000 ($140,000 in 2001). Each year's contribution must be calculated by an actuary -- the exact amount depends on your income, the target benefit, years until retirement and anticipated investment returns. Annual actuarial fees and the required IRS report can run up to a couple grand. Another negative: You're locked into making the actuarially determined contribution each year. However, if you make good bucks and are over 50, a defined benefit plan may be worth all the trouble -- because it permits much bigger contributions than any other type of program. If you're younger, go with a SEP or profit-sharing Keogh.
Roth IRAs -- Retirement Plan Dessert
OK, you've now decided to set up a SEP or Keogh plan. But in the true American tradition of greed you still want more, more, more retirement tax breaks. Fine. Take a good look at a Roth IRA. Contributions are nondeductible, but earnings build up tax-free and you can eventually take out all your money -- including earnings -- without owing Uncle Sam a dime.
For 2002, contributions up to $3,000 ($2,000 in 2001) are allowed ($6,000 for couples), subject to phaseout between adjusted gross income of $95,000 and $110,000 for singles ($150,000 and $160,000 for joint filers). Fortunately, the phaseouts are high enough to leave most people untouched. The same relatively generous thresholds apply even if you have a SEP or Keogh plan (and even if your spouse is covered by a company retirement plan at work). So you can contribute the max to your SEP or Keogh and then pop an additional $3,000 (or $6,000) into a Roth IRA to boot. Thank you, Congress.
Deductible IRAs
While the deductible IRA is a poor stepchild to other self-employed retirement plan choices, you should know one thing. If you have a Keogh or SEP plan for yourself but your spouse isn't covered by a qualified retirement plan, he or she can make a deductible IRA contribution up to $3,000 for 2002 ($2,000 for 2001) -- as long as family AGI is below $150,000. (The deduction is phased out between AGI of $150,000 and $160,000.) While this is all well and good, contributing to a Roth IRA will usually save more taxes in the long run.
If You Have Employees...
If your business has employees, a SEP must cover them as well -- meaning you'll have to make contributions that don't just benefit yourself. All employee SEP contributions are immediately 100% vested. With both Keogh profit-sharing and pension plans, employees cause lots of complications. The tax guidelines may require you to cough up money on their behalf while limiting contributions for yourself. The existence of employees means you should consult a good employee benefits pro before initiating any type of retirement program (other than a traditional or Roth IRA).
THERE'S MORE to being your own boss than not having to answer to anybody: You can also set up your own tax-advantaged retirement program -- and probably put aside more each year than you could working for somebody else. 
