December 11, 2000, 4:45 PM — One of the biggest drawbacks to setting off on your own as a consultant or
freelancer is losing company-funded retirement plans such as 401ks and pensions. But
unless you've already socked away enough money for retirement, it's not a good idea to
stop saving for the future just because you've lost access to such employer-sponsored
plans. Luckily, there are numerous tax-advantaged -- albeit self-funded -- vehicles for
putting money aside for the day when you stop working. And more options may be coming
soon.
I have been a full-time freelance writer since mid-1998, and I've pored over
financial Websites and Internal Revenue Service (IRS) publications more than is
probably healthy. I've been looking for retirement plans with high contribution limits
and a lot of tax advantages, plans with built in flexibility so that they can be put to
use for college and emergencies as well as retirement if need be. I've learned a few
tricks, dispelled some myths, and gotten a grasp on the pluses and minuses. My advice
should be pretty universal, but bear in mind who it's coming from: I'm an
unincorporated sole proprietor with no employees, a middle-income,
living-below-my-means do-it-yourselfer who would no sooner hire an accountant than I
would keep Emeril Lagasse around as my personal chef.
The basics
Retirement plans for one-person microbusinesses vary chiefly in their annual
contribution limits and in how they're reported to the IRS. They all let you buy into
the broad range of stocks, bonds, mutual funds, money markets, and other investments
offered by thousands of banks and brokerages, and are tax deductible.
Keogh plans let you contribute the most money -- up to around 19 percent of your
adjusted business income (the latter being what you clear after expenses, minus half
the self-employment tax, minus the contributions themselves). The annual contribution
can't exceed $30,000. Sales literature for all these plans often throws out
impressively high round numbers like 25 and 15 percent , but if you're self-employed,
your actual contribution is always reduced to a "percentage equivalent" that's about
three-quarters the advertised number.
There are four types of Keoghs. Money-purchase plans require you to commit
to a minimum annual contribution of about 3 percent of adjusted business income, but
they also allow the highest contribution. Profit-sharing plans vary your
annual contributions based on how well your business did, from zero to a top limit
around 11 percent annually. Defined-benefit plans guarantee a certain income
in retirement, like corporate pension plans do, and are harder to fund and administer.
I chose a fourth type, called a paired plan. This plan provides the most
flexibility, letting me contribute the profit-sharing maximum (about 11 percent of
income) as well as nearly 8 percent to a money-purchase plan, while locking me in to
only the money-purchase contribution.
Another popular plan is called the Simplified Employee Pension (SEP) Individual
Retirement Account (or IRA -- to the IRS, the a stands for
arrangements). SEP IRAs let you contribute and deduct substantially less than
Keoghs: you can put in anything from nothing up to about 12 percent of your income, all
of it deductible. The cap is also $30,000.
SEP IRAs are said to be as easy to establish and contribute to as regular IRAs, and
that's their main attraction over Keoghs. But it's a myth that Keoghs are much harder
to administer for individuals, though they may be if you have employees. My broker,
Fidelity Investments (Boston) reduces the process to a few simple forms, and its
customer-service reps are a free call away. You do have to write separate checks for
each type of Keogh, making sure to keep their account numbers and percentages straight.
But a special year-end report to the IRS (merely a longish form) must only be filed if
assets exceed $100,000. I spend maybe six hours a year administering my Keogh, a small
price to pay for the higher contribution limit.
Savings Incentive Match Plans for Employees (SIMPLEs) have smaller contribution
limits that generally can't exceed $6,000. They are technically salary-reduction plans
with employer contributions, a small-business 401k of sorts. There's little point in
having one unless your income is modest or you plan to add employees and want low
contribution limits. Since your combined contribution to all plans is capped at around
19 percent (or $30,000) by law, it's fruitless to use a SIMPLE IRA to supplement the
other higher-limit plans.
