The Natural Angle: Planning Ahead

May 2001

Planning Ahead

Retirement can be a touchy subject for anyone, but for the self employed, it can be especially stressful.

How much you should sock away each month, and how much you can afford to sock away each month, are two issues that - unfortunately - can have very different answers. For those who have been working on their own for some time, the question of what you need to put away for those golden years often has been answered - but deciding the best place to put it can be another matter entirely.

Preparing yourself for the years ahead when you'll while away the days playing pinochle can be daunting in the best of circumstances. While Social Security will add a little to your monthly income, in no way can the Social Security System provide retirees with enough to live comfortably, even those who pay twice as much into the system as everybody else - i.e., the self-employed.

Anyone who works on their own can vouch for the sting of the self employment tax, which requires those working on their own to pay both the employee's and employer's share of the tax, or about 12% of what they earn. Toss in the required contribution to Medicare, and that percentage jumps to 15. On top of that 15%, the self-employed absolutely must consider opening either a Keogh Plan, an Individual Retirement Account (IRA), or a Simplified Employee Pension (SEP). These three are the most popular choices for retirement saving among the self-employed, perhaps in part because all are recognized by the Internal Revenue Service.

According to Grace W. Weinstein, author of Financial Savvy for the Self-Employed, these so-called tax-qualified plans have two distinct advantages: 1.) Your money grows faster because you don't pay tax on interest and dividends as they accumulate; and 2.) Due to the rather stiff penalties induced you're unlikely to raid the account should your cash flow hit a dry spell.

That, say retirement experts, is key to having a secure future.

So just what are Keogh Plans, IRAs and SEPs? And which is best for you?

In determining which of the qualified retirement plans provides you the best benefit may require the assistance of a professional accountant or investment broker. However, for those both willing and able to do a little research, deciding which plan to use can be done on your own.

Keogh Plans allow your to put away a specified percentage of your income each year for retirement - the contribution is deductible and any earnings that accumulate are tax deferred, which means no tax is due on interest or dividends until the money is withdrawn. Keogh Plans can be configured in three differing forms, allowing the plan some flexibility in meeting future retiree needs. Information on establishing a Keogh Plan can be gotten at almost any bank, mortgage house, brokerage firm or insurance company.

The well known IRA is another viable option for the self-employed, especially those earning below $25,000 individually or $40,000 as a couple. The IRA allows you to put away up to $2,000 a year for retirement, but the contribution is only deductible if you earn below the amounts specified above. The IRA contribution is partially deductible up to a $35,000 annual income for an individual or $50,000 for a couple; anyone making more than that, however, cannot deduct IRA contributions. The earnings continue to be tax deferred, however.

The retirement plan many financial experts think worth investigating, however, is the Simplified Employee Pension (SEP), because it is simpler to oversee and more flexible than both the Keogh and the IRA. With an SEP you can contribute whatever you want each year, up to 15% of your annual income or $22,500 per year. In particularly lean years you can skip contributions altogether without concern. In addition, the SEP requires less IRS paperwork, another plus, especially for the self employed individual who takes care of their own tax work.

Deciding which plan is best for you can be the toughest part - once your retirement account is set up, taking care of it typically becomes part and parcel of doing business. And remember - the plan that provides the best fit today may not fit 10 years down the road, so - as in every other aspect of self-employment - remain flexible. Your retirement plan may change because you take on employees, or because your income rises significantly. Whatever the case, revisit the issue every five years or so. Having a strong pension plan is crucial to a healthy retirement.

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