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Supersize savings
What if you’ve fallen behind in your savings and retirement is looming near? Despite the generosity of the solo 401(k), you might still need to save a bundle more if you’re going to reach your goals. Don’t despair. There are plans that will let you do some serious catching up while Uncle Sam subsidizes your efforts: solo defined-benefit plans.
These traditional pensions are one-person versions of the same plans that were once commonly offered by large corporations. But now the smallest businesses are turning to solo defined-benefit plans because they allow owners to sock away significantly more money than they can in solo 401(k)s. It’s not uncommon for a well-heeled sole proprietor to stash upwards of $100,000 a year in such a plan, says Sallie Olson, senior consultant with AKT Retirement Plan Services, in Portland, Ore. And the money is tax-deductible.
A solo defined-benefit plan operates under the same rules as a traditional pension for a corporation. You figure out how much you want the plan to pay you each year in retirement, then you contribute enough to make the desired payouts possible over your life expectancy. Annual contributions are mandatory at least until the plan is fully funded, and they’re calculated by an actuary. These plans work best for entrepreneurs close to retirement, says Olson. You’ll also need to pull in a high income, have plenty of cash to contribute and be able to maintain that earnings power for several years. Otherwise, you’d do better sticking with the solo 401(k).
The paperwork can be a nightmare. Luckily, financial-services firms are taking note of the rising demand, and more are offering what Olson calls “plans in a box.” Companies such as Charles Schwab and Pioneer Investments, for example, now offer solo defined-benefit plans and will guide you through the labyrinth of calculations and forms. Set-up and administrative fees run higher than with a solo 401(k)—from a few hundred to a few thousand dollars a year—but it may be worth the cost to capture that huge savings potential.
Other options
With all the pluses of the solo 401(k), it can be easy to overlook traditional small-business plans, such as the SEP IRA, SIMPLE IRA and Keogh. But those offerings may still have a place in your savings strategy. For example, what if your business is something you do on the side, and you still work for an employer? Assuming you max out your 401(k) at your day job, you cannot take advantage of the $15,000 limit again with a solo 401(k).
However, you can open a SEP IRA for your small business and save up to 20% of your self-employment income (or 25% of your compensation, if your business is incorporated). And you get the same dollar-for-dollar tax benefits as with the solo 401(k). SEPs are easy to set up through brokers, banks and mutual fund companies, and they carry minimal account-maintenance fees. No catch-up contributions or loans are allowed with SEPs. But you can set up a SEP at the last minute. You have until you file your income taxes for the previous year to establish and fund your SEP.
Another option is a SIMPLE IRA, which stands for Savings Incentive Match Plan for Employees. These plans are also tax-deductible, but they limit your contributions by a set dollar amount instead of a percentage of your income. In 2006, you can save $10,000 of your self-employment income, and your business can kick in another 3%. People age 50 and older can tack on an extra $2,500 in catch-up contributions. SIMPLE IRAs do not allow loans.
You must set up your SIMPLE IRA by October 1 of the year for which you want to make your first contribution. But you have until April 15 of the following year to actually contribute the money.
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