Money Girl explains different types of retirement accounts you can use to grow a healthy nest egg.
Type #4: Solo 401(k)
A Solo 401(k) is sometimes called a Uni-k or a One-participant 401(k). It’s a traditional 401(k) that covers a business owner (and a spouse) who has no employees, perhaps like a freelance writer or photographer. You can make contributions as both an employer and an employee, because you wear both hats.
On the employee side, you can contribute 100% of earned income from the business up to $17,500 or up to $23,000 if you’re 50 or older. And as the business owner or employer, you can also contribute up to 25% of your compensation. However, your total contributions to a Solo 401(k) for 2013 generally can’t exceed $51,000.
But what if your business is a side hustle—like building websites or teaching music lessons on the weekend—and you also participate in a 401(k) at a second company? Then the total employee contribution you can make to both plans can’t exceed $17,500 or $23,000 if you’re 50 or older.
Type #5: SEP-IRA
But what if you’re a small business with employees? One of the easiest and least expensive retirement plans to administer is the SEP-IRA, which stands for Simplified Employee Pension. It’s an option for any size business or those who are self-employed.
With a SEP-IRA, you contribute to a traditional IRA for employees (including yourself), up to 25% of their pay. However, employees can’t make their own contributions. Employers can choose the amount to contribute each year, but must give all employees the same percentage.
For example, let’s say you have a small cleaning business with one employee named Sally. If you choose to contribute 20% of your pay to your SEP-IRA, you’d also have to contribute 20% of Sally’s pay to her SEP-IRA.
But if you have a bad year with little profit, you can choose not to make any contributions. This flexibility allows a small business to manage cash flow and have the benefit of a simple retirement plan that requires very little paperwork.
Employees are always vested in their SEP-IRA account, which means if Sally leaves your employment, she can take her retirement money with her.
Type #6: SIMPLE IRA
A SIMPLE IRA is another inexpensive retirement account option for any size business, with little administrative hassle and paperwork. However, it’s generally best for companies with 100 or fewer employees.
SIMPLE is an acronym for Savings Incentive Match Plan for Employees. It allows employers to contribute to traditional IRAs; however, it’s different from a SEP-IRA because employees can also put money in their accounts. For 2013 employees can contribute up to $12,000 or $14,500 if you’re age 50 or older.
Employers have 2 choices for how to make contributions to a SIMPLE-IRA:
Matching contributions: They can match what an employee contributes, dollar-for dollar, up to 3% of compensation. In this scenario, if an employee doesn’t contribute to his or her account, then that employee doesn’t receive any contributions from the employer.
Nonelective contributions: They can make flat contributions of 2% of pay, regardless of how much an employee puts in. In this scenario, an employee who doesn’t contribute any amount to their retirement plan will still receive an employer’s contribution equal to 2% of salary.
Either way, an employee is always 100% vested in all their SIMPLE IRA money.
The retirement plans that I’ve covered in this series are the most common, but there are more than 6. IRS Publication 590, Individual Retirement Arrangements, gives details about all the plans available for individuals. And IRS Publication 560, Retirement Plans for Small Business, can help you explore options for your business endeavor.
If you need help setting up a retirement plan or aren’t sure how to use multiple retirement plans properly, be sure to contact a qualified tax accountant. Paying a consulting fee to get clarity on these accounts can pay dividends if it saves you taxes and helps you build a cushy retirement account for the future.
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