Self-Employed Retirement Plans

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OCEAN CITY – Setting up a retirement plan can require time, money and a fair amount of administrative legwork — all of which can be in especially short supply for those who not only operate their own small businesses but are their own small businesses. Yet choosing a retirement plan is a crucial step for the self-employed "and well worth the effort," says Timothy G. Curran, vice president of Retirement and Benefit Plan Services at Bank of America Merrill Lynch.

"It’s essential that small-business owners not end up with all their assets tied up in their businesses," says Curran. "Setting money aside for retirement gives you diversification and the ability to focus on building your business while a professional financial advisor helps you invest so that you can pursue your retirement goals."

And no matter how much you love going to work every day, you probably want to retain some control over the decision of how long you continue to work. Having a retirement plan in place can help provide you not only with security, but with freedom as well.

Many self-employed people decide to forgo retirement planning because they believe they don’t have the options that come with being a part of a larger company. But in fact, solo entrepreneurs and independent contractors with no employees often have more options and greater flexibility in building their nest eggs than the rest of the working world.

"Whether you want to be able to access capital for your business or change your contribution level from year to year, there’s a plan that will suit your personal and business needs," says Curran.

Here are four plans that Curran suggests the independently employed might want to consider to start the conversation.

– Simplified Employee Pension (SEP) IRA: Relatively easy to open and inexpensive to maintain, SEP IRAs allow the self-employed to contribute a hefty 20 percent of their net income annually (or income minus half of their self-employment tax) up to $49,000. Contribution levels can be changed from year to year, which benefits those whose income and business liquidity needs fluctuate, says Curran. "You can have a great year and contribute 20 opercent and then the next year lower that contribution to 5% or even zero percent if you want," he said.

In addition, a SEP IRA holder can withdraw funds at any time, although withdrawals are subject to income tax and a 10-percent penalty for anyone under age 59½.

– Simplified Matching Plan for Employees (Simple) IRA: Typically used by small businesses with 100 or fewer employees, Simple IRAs can also be appropriate for a solo entrepreneur who intends to hire employees and provide them with a retirement plan down the road. A Simple IRA allows the business owner, as well as employees under age 50, to defer as much as $11,500 of their annual salaries; those 50 and older can contribute an additional $2,500 annually. Employers must also choose an employer contribution formula — in the form of either a dollar-for-dollar match of the employee’s contribution, up to 3% of his or her annual compensation, or a straight 2% of the employee’s annual compensation, regardless of the employee’s participation in the plan (up to a maximum of $245,000).

Solo 401(k): Also known as the self-employed 401(k) or the individual 401(k), this is a great option for solo entrepreneurs who want to save as much as possible, up to $49,000 annually for those under age 50, $54,500 for those age 50 and up) while retaining the flexibility to adjust contributions on an annual basis. The plan allows for both an individual contribution, in the form of a salary deferral of as much as $16,500 ($22,000 for those over 50) and a business contribution of up to 25% of total compensation — which enables business owners to defer more money on the same salary than would be possible with a SEP. Furthermore, self-employed 401(k) holders can opt to make Roth 401(k) contributions and pay taxes on the individual contribution portion of their retirement savings.

Defined-Benefit Pension Plan: This plan, geared toward high-income self-employed people, allows investors to defer as much as $195,000 yearly in income. Annual contributions are based on statistical estimates of average life expectancy and are designed to deliver a target benefit at a retirement age. The higher the target benefit, the larger the contribution needs to be. The catch? Once set, the contribution stipulated in the plan is fixed and must be made every year. "If your business is having a bad year, you still have to make the contribution — even if you have to borrow money to do it," says Curran. "So a defined-benefit plan should not be set up lightly."

The plan that offers the best fit for you will depend on a number of factors, ranging from how much you can afford to contribute to the likelihood that you might need to borrow against retirement savings for purposes such as business expansion or managing cash flow. More reasons that you should review your choices with a Financial Advisor and tax professional to help you to pick the right plan for your personal and business goals.

(A Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-8520.)

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