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Plan now, play later


Forbes magazine reported last year that the number of people who are self-employed increased from 1.3 million in 2001 to 10.6 million in 2012. This big increase partly reflects the harsh economic reality and the still subdued job market. It also partly reflects people’s changing attitude towards work/life balance.

More and more businesses have also started increasing the hiring of contractors, while reducing full-time employees with benefits. This shift from a W2 (a tax form for salaried employees) to a 1099 (a tax form for contractors) economy is expected to accelerate in the future.

For people who are self-employed, one of the biggest mistakes is not to make an adequate plan for their retirement. Many self-employed people cite the lack of a corporate pension and 401k plan as their reasons. But they don’t realize that there are many retirement plan options available for the self-employed. Some plans don’t cost much at all.

If you are a one-person shop, a “Simplified Employee Pension” (SEP or sometimes called SEP-IRA) will be a good choice for you.  You contribute as much as 25 percent of your net earnings from self-employment, up to $51,000 for 2013. (Go here for a detailed calculation.) SEP does not have the same reporting and disclosure requirements as more complicated plans so it is very easy to set up and the cost to maintain it is very low.

Many mutual funds, banks, and other financial institutions offer IRS-approved “prototype SEP plans”. The best part about a SEP is low cost and flexibility. Discount brokers such as Scottrade offer no fee SEPs. You don’t have to fund a SEP until you file your annual tax return. Another benefit of SEP is that if you work for someone else while building your own business, your SEP contribution will not interfere with your other retirement plans through your regular employer.

Another option is to set up a “solo-401(k),” “individual 401(k)” or “uni-401(k).” It is generally the same as other 401(k) plans. As an employee, you can make salary deferrals up to $17,500 in 2013 (plus an additional $5,500 if you're 50 or older) of your compensation from the business either on a pre-tax basis or as a designated Roth contribution (after-tax basis) As an employer, you can contribute an additional 25 percent of your net earnings from self-employment, up to $51,000 for 2013.

Like a regular 401k plan, you can also get a loan from the plan or get a hardship distribution if needed. I don’t recommend borrowing from your plan unless it’s a serious situation. However, it is nice to have the option to borrow. Setting up a solo 401k is a little more complicated than setting up a SEP and many institutions will charge you a fee to set it up and maintain it.

If you think your business is going well and you want to set up a large sum of funds for your retirement, a solo 401k is a good way to go.  Unlike a SEP-IRA, if you are working for someone else and participate in that employer’s 401k plan, your contribution to the solo-401k will be limited.

There are some other retirement plans available such as Keogh plan and Simplified Employee Pension (SIMPLE). You may want to consult an advisor to find out which one is best for you.  Whatever plan you choose to set up, do it now and pay yourself first so you can have a financially secured golden years.

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Helen Raleigh

Helen Raleigh, CFA is the owner and Chief Investment Officer for Red Meadow Capital, LLC, a Colorado Registered fee-only Investment Advisory Firm, which focusing on providing clients with honest and sound financial advice. She has more than 10 years experience in the financial services industry ranging from pension funds to risk management. Helen is the author of an autobiography, "Confucius Never Said."  She writes insightful columns and blogs for a variety of media outlets and her writings can be found at the Wall Street Journal, the CFA Magazine, the Denver Post and her blog postings. She can be reached at: helen.raleigh@redmeadowadvisors.com

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