Retirement security is a concern for everyone. But when you’re self-employed, you really have to think about the future. Just as you’re responsible for generating your own income now, you’re going to be pretty much on your own during your retirement years. With the exception of Social Security and any benefits you receive from former employment, your retirement income will have to come from your savings and investments. A tax-favored retirement plan can help you prepare.
You can choose from several retirement plans. All allow you to make tax-deductible contributions. And those contributions, along with investment earnings, grow tax deferred until withdrawn from the plan. Here are three options you might consider:
This plan is suitable for someone who works alone or employs only his/her spouse. It has relatively high deductible contribution limits. For example, in 2012 you’re allowed to defer up to $17,000 ($22,500 if you’ll be at least age 50 by December 31) plus contribute another 25% of “earned income,” as defined in the tax code (25% of your compensation if you’re a corporate employee) — for a maximum contribution of $50,000 ($55,500 if you’re age 50 or older).
One of the least complicated plans, the SEP IRA allows you to make tax-deductible contributions to individual retirement accounts (IRAs) established for yourself and your eligible employees. You don’t have to contribute to the plan every year, but if you make a contribution for yourself, you also have to contribute to each eligible employee’s account (generally a uniform percentage of compensation). In 2012, the most you can deduct is 25% of “earned income” (25% of compensation if you’re a corporate employee) subject to a contribution dollar limit of $50,000.
With this plan, you set up an IRA for yourself and each participating employee. Employees (and you) elect to defer compensation to the plan (no more than $11,500 in 2012; $14,000 if age 50 or older). An additional employer contribution is required annually. You must either: (1) match employee contributions up to 3% of pay (a lower 1% match is allowed in certain years) or (2) contribute 2% of pay for each employee who’s eligible to contribute, even if the employee chooses not to contribute.