Employers, Pay Yourself First - Invest in Your Retirement

By Nancy Zambell, Contributing Editor, Financially Fit

In last week's Financially Fit issue, we discussed IRAs (Individual Retirement Accounts) in great detail. In this issue, I want to talk about retirement plans created specifically for the self-employed.

Contributions and deductions for individual IRAs and 401(k)s have become ever more liberal - providing fabulous opportunities for retirement fund growth. But the self-employed will find even greater benefits, including much higher maximum contributions, deductions and even tax credits of 50% of the costs associated with setting up certain retirement accounts, such as SEPs, SIMPLE or Qualified Plans.

Whether you are a sole proprietorship, partnership, corporation or "S" corporation, there is most likely a plan that will fit your needs.

Simplified Employee Pension (SEP)

With a SEP, employers may set up traditional IRAs or SEP-IRAs (not Roth IRAs) for their employees who are 21 or older, have worked for them in at least 3 of the previous 5 years and have received at least $450 in compensation for the year ($500 for 2007).

The employer is not required to make contributions every year, but if he does, the contribution must be equal for all employees, to a maximum of 25% of their compensation. Contributions to the employer's own plan and tax deductions are based on the profits of his company.

Contribution limits are the lesser of 25% of compensation, up to $220,000 of employee compensation, or $44,000 for 2006 and up to $225,000 of employee compensation, or $45,000 for 2007. Employers may contribute the same amounts to their own SEP-IRAs, but there are special rules for calculating their maximum deductible contributions. See http://www.irs.gov/retirement/article/0,,id=111419,00.html

A SEP can be set up and contributed to up to the filing deadline for that tax year.

One note: If an employer contributes to another defined contribution plan for his employees, additional contribution limits will apply.

Savings Incentive Match Plan for Employees (SIMPLE)

Businesses with 100 or fewer employees who received at least $5,000 in compensation in the previous year may elect to set up SIMPLE plans that take the form of either 401(k)s or IRAs.

Employees choose to contribute part of their salary to a retirement account and the employer then makes matching contributions. Employer contributions are not mandatory and can be skipped. Employees control how their money is invested, can take it with them when they leave and may use it at any time (subject to early withdrawal penalties)

For 2006 and 2007, the maximum employee contribution is $10,000 and $10,500, respectively, with a $2,500 catch-up provision for employees 50 or older.

In general, an employer is required to match his employee's contribution, up to 3% of the employee's compensation. And for his own SIMPLE plan, the employer can contribute a percentage of his net earnings, plus a matching contribution of up to 3% of his net earnings. See http://www.irs.gov/formspubs/article/0,,id=117542,00.html

Employees do not pay federal income tax on their or their employer's contributions to their plans. SIMPLE plans can be set up and contributed to up to the filing deadline for that tax year.

Qualified Plan (formerly known as Keogh or H.R. 10)

A sole proprietor or partnership may establish qualified plans that are more complicated than SEP or SIMPLE plans, but are more flexible and may allow greater contributions and deductions, in certain cases. These plans consist of defined benefit plans or defined contribution plans.

In a defined benefit plan, the benefits received are predetermined and actuarial assumptions are made to determine the amount of contributions that will fund that benefit. Benefits are limited to the greater of 100% of the participant's average compensation for his highest 3 consecutive calendar years, or a fixed dollar amount (which changes each year). For 2006 and 2007, that maximum is $175,000 and $180,000, respectively. And the maximum compensation on which they are based is $220,000 for 2006 and $225,000 for 2007. Deductions for an employer's contributions are based on the actuarial formula.

Contributions to a defined benefit plan can be made up to the due date of your tax return and are tax deductible.

Defined contribution plans allow annual contributions up to the greater of 100% of the employee's compensation, or a fixed dollar amount, which changes yearly. For 2006, that amount is $44,000; for 2007, it's $45,000.

Defined contribution plans may either be profit sharing plans (based on company profits) or money purchase pension plans (which require contributions even if the company is not profitable), each of which has its own set of rules regarding contributions and deductions.

In qualified plans, participants may also make their own contributions, but they are not tax deductible. However, accumulated earnings are tax-free until distributed. See http://www.irs.gov/newsroom/article/0,,id=163616,00.html

Qualified plans must be opened by Dec 31 of the tax year for which the deduction will be claimed, but contributions may be made up to filing deadlines for that year.

Self-employed 401(k) Plan

These plans are available to self-employed individuals and business owners, including sole proprietorships, partnerships, corporations and "S" corporations that have no employees (other than a spouse).

They can significantly reduce your tax bite as the entire amount of plan contributions may generally be deducted from your taxable income.

The plans allow three contribution levels:

• Employer profit-sharing contribution range of 0-25% of compensation, up to $44,000 for 2006 and $45,000 for 2007, subject to maximums of $220,000 and $225,000, respectively.
• Salary deferral contributions up to 100% of compensation, with a maximum of $15,000 in 2006 and $15,500 in 2007.
• Catch-up contributions of $5,000 for 2006 and 2007, if you are age 50 or older.

Note that the total of salary deferrals and profit-sharing contributions may not exceed $44,000 for 2006 and $45,000 for 2007.

Self-employed 401(k) plans must be set up by Dec. 31 of the tax year for which the deduction will be claimed, but contributions may be made up to filing deadlines for that year.

As you can see, the opportunity for self-employed individuals to rapidly grow retirement funds is much more generous than in traditional IRAs or 401(k) plans - a fabulous way to help ensure a secure retirement!

You should also be aware that you don't always have to establish a new retirement plan. If you have money socked away in an existing 401(k) (through a previous employer), a profit-sharing or money purchase plan, or even an old IRA, you may also be able to easily roll over or convert those funds into one of the above vehicles.

I recommend that you check with your investment and tax advisors to determine which plan may be of most benefit to you.

Now that we have the technical stuff out of the way, I want to clue you in on one more aspect of retirement funds that you may be unaware of - the variety of vehicles available for your investment monies.

Almost every investor knows that he can select stocks, mutual funds or exchange-traded funds (ETFs), or even bonds and bond funds, for his retirement accounts. For more detailed information on these subjects, please refer back to our Financially Fit issues of Aug. 1 and Aug. 15, 2006.

But what you may not realize is that the retirement universe is much more vast. Today, investors may choose to hold alternative investments in their retirement accounts, including:

• Certain gold & silver coins minted by the U.S. or by U.S. states
• High-quality gold, silver, platinum and palladium bullion
• Stock from initial public offerings
• Closely-held stock
• Real Estate
• Options to buy real estate
• Oil & gas royalty interests
• Stock options
• Mortgages and other loans held for investment

However, you may not hold life insurance policies, certain collectibles, including works of art, rugs, antiques, metals, gems, stamps, coins (except as noted above) and alcoholic beverages. See http://www.irs.gov/retirement/article/0,,id=111413,00.html#invest

Of course, you will need to check with your plan administrator as to their investment limitations and always with your investment advisor to ensure that you are maintaining a diversified portfolio, with the appropriate risk level for your personal profile.

With this information in hand, isn't it about time that you took care of yourself first? Happy retirement planning!

Until next week…

This concludes this week's issue of Financially Fit.  We encourage you to visit our website to review past issues of Financially Fit:

http://www.brokeradviser.com/newsletter.cfm


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