Self-Employed People & Retirement Plans Under the Law
If you are self-employed and have no employees, you will be able to design your own retirement plan. Just as if you were an employee, any contributions to the plan will be tax-deductible. Being self-employed means that you run your own business, you run a partnership with others, or you run a limited liability company or a limited liability partnership. Self-employed people also include independent contractors and people who do freelance work. People who run an S corporation or a C corporation are not classified as self-employed.
One key factor to consider when you are choosing your plan is the tax benefits that it will give you. Plans that provide for larger contributions tend to offer greater tax benefits. You also will want to determine whether the plan requires making contributions each year, since many people who run businesses find that their income varies. They may feel more comfortable with a plan that does not require an annual contribution. If the plan comes with substantial administrative costs, you may want to think about whether you want to undertake this burden. For example, you may need to make reports to the government or get assistance from an actuary who can calculate contributions. Regardless of the type of plan that you choose, you should be aware of the deadline for establishing it. You may need to establish your plan by the last day of the year in which you will make a contribution. In other situations, you may not need to establish a plan until the date that your income tax return is due.
Contribution requirements and limits
Choosing Among Retirement Plans
Three of the most typical options are SEPs (simplified employee pensions), solo 401(k) plans, and defined benefits plans. An SEP appeals to many self-employed people because it tends to be time-efficient and cost-efficient. Establishing a plan may involve merely completing a form, and you can usually start it for free. An SEP does not require a self-employed person to report information to the government or shoulder the burden of administrative costs. You can contribute up to 25 percent of your business income, up to a certain cap, and you do not have a minimum amount that you need to contribute. Nor do you need to contribute every year. An SEP does not need to be established until the extended due date of a self-employed person’s tax return.
Whether a self-employed person has employees may affect both the cost and types of plans available.
One downside of an SEP is the cap on contributions. The cap is more generous for a solo 401(k) plan, for which the cap also increases for people who are older than 50. It resembles an SEP in that you are not required to make contributions each year. However, maintaining these plans is more expensive than maintaining an SEP. You also will need to make the extra effort of filing a specific tax return related to the plan if the funds in it reach $250,000. A solo 401(k) needs to be started by the last day of the year in which you plan to make a contribution.
The most traditional option is a defined benefits plan. These are usually not attractive options except for people who are earning substantial income and want to make larger contributions to their plan. Annual contributions are required for these plans, and you will need to hire an actuary to help you calculate the annual contribution. In addition, you should consult a professional financial planner to make sure that you meet the technical requirements for setting up the plan. It will provide you with a set dollar amount of benefits after you retire on a monthly or annual basis.
Social Security and Retirement Planning Legal Center Contents