As we move closer to the end of the year those of you who are self-employed should be thinking about starting a retirement plan for yourself if you don't have one in place already. There are a number of options available, Below is a discussion of two: the simplified employee pension individual retirement account, or SEP-IRA, and the Solo 401(k).
- Can be opened at most major custodians and offers the same investment flexibility in terms of investment options as an IRA.
- Contributions for the prior tax year can be made up until your tax filing date, including extensions. This means that for 2012 you can still open and fund a SEP-IRA up until October 15, 2013 if you haven't filed yet and will be filing an extension.
- There are few if any reporting requirements.
- The limits for 2013 are up to 25 percent of compensation or a max of $51,000.
- Contributions are all made by the business.
Solo 401(k) Basics
- Includes both and employee deferral component and an employer deferral piece.
- Combined contribution limits for 2013 are $51,000, or $56,500 if you are age 50 or over at any point during 2013.
- Solo 401(k)s can be opened at most major custodians.
- Solo 401(k)'s are limited to solo employees, business partners and spouses.
When making your decision, here are a few comparisons and points to consider when choosing between the two:
- While a SEP-IRA can be used with employees in reality this can become an expensive proposition as you will need to contribute the same percentage for your employees as you defer for yourself. I generally consider this a plan for the self-employed.
- Both plans allow for contributions up your tax filing date, including extensions for the prior tax year. The Solo 401(k) plan must be established by the end of the calendar year.
- Note that the SEP-IRA contribution is calculated as a percentage of compensation. If your compensation varies, so will the amount that you can contribute to plan in a given year.
- By contrast, you can defer the lesser of $17,500 ($23,000 if you're 50 or over) or 100 percent of your income for 2013 into a Solo 401(k) plus the profit sharing contribution. This might be the better alternative for those with plenty of cash and a variable income.
- Loans are available from Solo 401(k)s, but not from SEP-IRAs.
- A Roth feature is available for a Solo 401(k) if allowed by your plan document. There is no Roth feature for a SEP-IRA.
- Both plans require minimal administrative work, though once the balance in your Solo 401(k) account tops $250,000, the amount of annual government paperwork increases a bit.
- Both plans can be opened at custodians such as Charles Schwab, Fidelity, Vanguard, T. Rowe Price, and others. For the Solo 401(k) you will generally use a prototype plan. If you want to contribute to a Roth account, for example, ensure that this is possible through the custodian you choose.
- Investment options for both plans generally run the full gamut of typical investment options available at your custodian such as mutual funds, individual stocks, ETFs, bonds, closed-end funds, etc. There are some statutory restrictions so check with your custodian.
Certainly there are other options for the self-employed. Depending upon your situation, business cash flow, and your level of income you might consider a SIMPLE plan, a cash balance pension plan, or other options. Don't forget about funding an IRA as well.
Being self-employed by definition means that you work hard. Don't forget to take care of your own financial needs including funding a retirement plan. If you have a plan in place make sure you fund it. If you don't, this is a great day to start one.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.