I am often asked about the best retirement plans out there for entrepreneurs and sole proprietors. There are a lot of choices and depending on your circumstances, one may be more appropriate than another.
Contribution Limit: Up to $6,000 in 2019, plus a $1,000 catch-up contribution for those 50 or older.
Tax Deductibility: For contributions to a traditional IRA, the amount you can deduct may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels. Roth IRA contributions aren’t deductible.
Contribution Deadline: Tax return filing deadline (not including extensions).
Pros: Easy and best first plan for those just starting out or not earning a lot.
Cons: Low funding limit; only available to an individual, not to other employees.
Simplified Employee Pension (SEP-IRA): This is a good option for those who have up to 25 employees and want to offer a retirement benefit that is easy to operate.
Contribution Limit: The lesser of: 25 percent of your net earnings from self-employment (net profit less half of your self-employment taxes paid and your SEP contribution), up to $56,000 for 2019, with a $280,000 limit on compensation.
Tax Deductibility: To qualify for the deduction, complete IRS Form 5305-SEP, or an IRS-approved “prototype SEP plan”, offered by many mutual funds, banks and other financial institutions, and by plan administration companies.
Contribution Deadline: You can establish and fund the SEP plan as late as the due date (including extensions) of your income tax return for that year.
Pros: Available to any size business; low cost; no filing requirement for the employer; and open to all eligible employees.
Cons: Only the employer contributes, so the burden is on her shoulders alone. Additionally, contribution percentages must be equal to the ones you make for yourself, which can add up. Also, there is no Roth version of a SEP IRA.
Savings Incentive Match Plan for Employees (SIMPLE IRA Plan): SIMPLE plans were aimed at slightly larger small business owners (usually up to 100 employees), who wanted to provide employees a way to save for retirement.
Contribution Limit: Net earnings from self-employment up to $13,000 in 2019, plus an additional $3,000 if you're 50 or older, plus an employer contribution of either a 2 percent fixed contribution or a 3 percent matching contribution. The compensation limit for factoring contributions is $280,000 in 2019.
Tax Deductibility: Establish the plan by completing Form 5305-SIMPLE, Form 5304-SIMPLE, or an IRS-approved “prototype SIMPLE IRA plan” offered by many mutual funds, banks and other financial institutions, and by plan administration companies. Contributions made to employee accounts are deductible as a business expense.
Contribution Deadline: You can establish a SIMPLE IRA plan at any time January 1 through October 1. If you became self-employed after October 1, you can set up a SIMPLE IRA plan for the year as soon as administratively feasible after your business starts.
Pros: Employees can contribute through salary deferral; less paperwork and testing than a standard 401 (k).
Cons: Employers are required to make contributions; there is an early withdrawal penalty of 25 percent if participants withdraw within the first two years of participation in a SIMPLE IRA.
Solo 401(k) plan: Alternatively referred to as an “individual 401(k)” or “uni-401(k),” this plan is geared to small business owners who have no employees (other than a spouse) and have the capacity to sock away a lot of dough.
Contribution Limit: Salary deferrals up to $19,000 in 2019, plus an additional $6,000 if you're 50 or older, either on a pre-tax basis or as designated Roth contributions. You can add another 25 percent of your net earnings from self-employment for total contributions of $56,000 for 2019, including salary deferrals. The limit on compensation that can be used to factor your contribution is $280,000 in 2019.
Contribution Deadline: Plan must be established before calendar year end and funding allowed up to tax filing deadline (including extensions).
Pros: You may be able to put more money into a 401(k) than a SEP due to the way the contribution levels are calculated.
Cons: More paperwork than a SEP
Other retirement plans:
Two options, which are not used as much today, include a Profit-sharing plan, where you can decide how much to contribute on an annual basis, up to 25 percent of compensation (not including contributions for yourself) or $56,000 for 2019; and a Money purchase plan, which requires you to contribute a fixed percentage of your income every year, up to 25% of compensation (not including contributions for yourself), according to a formula stated in the plan.
Defined benefit plans: If you make a lot of money and want to sock away a ton for retirement, you can establish you own pension plan. These are very tricky, not to mention expensive, so you will need to spend money establishing and maintaining them and also funding them for a number of years. The reason to jump through all of the hoops is that defined plans can allow you to sock away more than $200,000 pre-tax.