Ask the Expert: Retirement Plans

Question:

What are the best retirement plans for the self-employed?

Answer:

If you are self-employed or have a side business in addition to another job, the best retirement-savings options are solo 401(k) plans (either Roth or regular) or a Simplified Employee Pension (SEP). Both plans allow tax-deductible contributions that grow tax deferred until you withdraw the money. If you opt for the solo Roth 401(k) plan, contributions are taxed, but withdrawals are not, and, depending on your personal situation, this may be the way to go. Here’s a quick look at the pluses and minuses of each.

SEP: With a SEP, you are able to contribute 20 percent of your net self-employment earnings with a limit of $51,000 for 2013. A big advantage for a SEP is that it doesn’t require a lot of paperwork or reporting requirements. Most financial firms can offer a SEP. The SEP’s flexibility means you don’t need to fund it until you file your tax return. So, based on your tax bill, you can choose to contribute more or less to your SEP. Also, if you are already covered by a 401(k) with an employer, SEP contributions don’t interfere with your current 401(k) plan. However, if you have employees who meet certain standards, you must make the same percentage contribution as you make for yourself. Spouses are exempt.

Solo 401(k): These plans give you some of the best of both worlds: You can make contributions as both an employee and employer, so you can potentially shelter more money at lower income levels. The maximum limit is the same as the SEP, but, if you are 50 or older, you can set aside $5,000 more. One of the downsides of solo 401(k) plans is that the paperwork and reporting requirements are significantly higher than for the SEP and fewer financial firms can set up a solo 401(k). Unlike the SEP, you are not allowed to double dip. If in your current job you have a 401(k) plan, contributions to your solo 401(k) count against your employer’s plan.

Visiting with a financial professional may help you decide which one is best for you.

This article appears in the March 2014 issue of Hawaii Business Magazine.