Before the new tax
laws were enacted, SEPs and Keoghs were the only recommended varieties
of qualified retirement plans for self-employed folks. Both are great
tax shelters. You get a current deduction for your contribution plus you
get compounded tax-deferred growth -- there's no tax on earnings until
you start drawing down the account. Now, on top of these time-honored
qualified plans, the new Roth IRAs provide an excellent supplemental tax
break.
Here's what you need to know to squeeze the most out of these
self-employed retirement plan options.
SEPs -- Simple and Good
Simplified employee pensions -- referred to as SEPs or SEP-IRAs -- are
generic retirement plans that allow you to contribute and deduct up to
13.04% of self-employment income (15% of salary if you're an employee of
your own corporation). Currently, the maximum annual contribution is
around $24,000. However, the percentage can be varied each year, so
lower amounts (or nothing at all) can be contributed when you turn out
to be starved for cash.
SEPs are great for procrastinators because they can be opened up as late
as the extended due date of your income tax return. Finally, SEPs are
much simpler to establish and administer than Keogh profit-sharing and
pension plans. It literally takes only minutes to get one started --
usually with no charge -- with a bank, brokerage firm or insurance
company. No annual government reports are required, and ongoing
administrative expenses are nil. The bottom line is SEPs are just as
easy as deductible IRAs, but they allow much bigger contributions.
Keogh Plans
Keogh plans are the self-employed equivalent of corporate retirement
programs. They come in two basic flavors: profit-sharing plans and
defined-benefit pension plans. To get a deduction for the current tax
year, the plan must be established before year's end. Once that's done,
actual contributions can be deferred until the extended due date for
that year's return.
Annual contributions to Keogh profit-sharing plans are based on a
percentage of self-employment income (up to 20% vs. 13% for SEPs)
subject to a $30,000 ceiling. Lower percentages are OK, too. A plan
document must be drafted in Year One (this may cost a couple hundred
bucks), and the IRS demands an annual report (you can probably do this
yourself).
Keogh defined-benefit pension plans are designed to deliver a targeted
annual retirement benefit, which can be as high as $130,000. Each year's
contribution must be calculated by an actuary -- the exact amount
depends on your income, the target benefit, years until retirement and
anticipated investment returns. Annual actuarial fees and the required
IRS report can run up to a couple grand. Another negative: You're locked
into making the actuarially determined contribution each year. However,
if you make good bucks and are over 50, a defined benefit plan may be
worth all the trouble -- because it permits much bigger contributions
than any other type of program. If you're younger, go with a SEP or
profit-sharing Keogh.
New Roth IRAs -- Retirement Plan Dessert
O.K., you've now decided to set up a SEP or Keogh plan. But in the true
American tradition of greed you still want more, more, more retirement
tax breaks. Fine. Take a good look at the new Roth IRAs, which became
available in 1998. Contributions are nondeductible, but earnings build
up tax-free and you can eventually take out all your money -- including
earnings -- without owing Uncle Sam a dime.
Contributions up to $2,000 are allowed ($4,000 for couples), subject to
phaseout between adjusted gross income of $95,000 and $110,000 for
singles ($150,000 and $160,000 for joint filers). Fortunately, the
phaseouts are high enough to leave most people untouched. The same
relatively generous thresholds apply even if you have a SEP or Keogh
plan (and even if your spouse is covered by a company retirement plan at
work). So you can contribute the max to your SEP or Keogh and then pop
an additional $2,000 (or $4,000) into a Roth IRA to boot. Thank you,
Congress.
Deductible IRAs
While the deductible IRA is a poor stepchild to other self-employed
retirement plan choices, you should know one thing. As of 1998, if you
have a Keogh or SEP plan for yourself but your spouse isn't covered by a
qualified retirement plan, he or she can make a deductible IRA
contribution up to $2,000 -- as long as family AGI is below $150,000.
(The deduction is phased out between AGI of $150,000 and $160,000.)
While this is all well and good, contributing to a Roth IRA will usually
save more taxes in the long run.
If You Have Employees...
If your business has employees, a SEP must cover them as well -- meaning
you'll have to make contributions that don't just benefit yourself. All
employee SEP contributions are immediately 100% vested. With both Keogh
profit-sharing and pension plans, employees cause lots of complications.
The tax guidelines may require you to cough up money on their behalf
while limiting contributions for yourself. The existence of employees
means you should consult a good employee benefits pro before initiating
any type of retirement program.
See articles in RED on
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