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Independently employed? What’s your retirement plan?

I’ve been independent since August 2008, and prior to that I had been contributing to my company-sponsored 401(k) since college (at each of my three previous full-time jobs).

When I went solo, I was given the option to keep my money in my last company’s 401(k) plan indefinitely — but obviously without their matching contributions. I did that for two years, and am kind of ashamed to admit that while I’ve been building my own business, I stopped contributing to my retirement. I was afraid to put money somewhere I couldn’t touch it.

A few months ago, I got to a point financially where I felt I could start saving for retirement again, and emotionally I knew it was time. I’m only 28, and I’ll probably never retire, but it would be foolish to think that at 60+ years old that I’ll have the same revenue-generation ability that I do now. I won’t.

I moved my old 401(k) into a Rollover IRA at TD Ameritrade. They have great customer service, and a branch not too far from where I live. I watch Suze Orman every Saturday night on CNBC (or the next morning when I’m nursing my hangover), and she’s always raving about Roth IRAs, so I decided to check them out.

After a bit of investigation, I realized that a Roth IRA wasn’t going to work for me due to salary and contribution limitations. I felt stuck.

I tweeted about looking for a financial advisor, and I’m quite lucky that Ben Shapiro a.k.a. @bennytheshap made an intro to his amazing mother-in-law, Debra A. Webber of Evanston Advisors. Deb gave me an hour-long consultation, free of charge, and in that short time completely changed my financial future.

Deb opened my eyes to a lot, but one of the most revelatory things she told me about is called a Simplified Employee Pension Individual Retirement Account, or SEP-IRA (pronounced Sep-I-R-A) for short. A SEP-IRA is a retirement plan for business owners and their employees, and it’s a dream come true.

Now look, I consider myself a pretty well-informed person and I yet had NEVER heard of this before. In 2.5 years of self-employment, my high-priced accountant had never once brought it up. I’d never seen it on an episode of the Suze Orman Show or read about it in any Dave Ramsey book. That’s why I feel responsible to tell all you indies about it today.

The benefits of a SEP-IRA:

  • Contributions are tax-deductible — meaning they’ll lower your taxable income in the current year
  • The annual contribution limit is the lesser of 25% of your income, or $49,000 — MUCH higher than the $5,000 limit of a traditional IRA or Roth IRA
  • Funds can be invested the same way as any other IRA
  • Contributions and earnings can be rolled over tax-free to other IRAs and retirement plans
  • It has no associated fees if you don’t have any employees, and minimal fees if you do

Of course it’s not exactly that simple. A few crucial details:

  • The annual contribution limit of 25% is constrained to the first $245,000 of income
  • Your contribution to a SEP-IRA is tax deductible, and will therefore reduce your contribution limit by whatever you contribute
  • The calculation of the actual contribution limit for a self-employed contributor is based on net profit minus one-half self-employment tax minus the contribution for him or herself

Read more about a SEP-IRA on the IRS website and at Investopedia.
Note: Make sure you talk to an accountant or tax planner to understand the full implications of the contribution.

You’ve got until your tax filing date (April 15 for most of us) to open an account and make your contribution for 2010. But seeing as there’s 16 days left in the year, start 2011 off right and take care of it now. It’s been a tremendous weight off my shoulders, and I’d love for you to feel the same.

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  • http://www.zaowebdesign.com Justin Sainton

    Such a great post! I’m self-employed and SUPER passionate about investing well. Great stuff! And to come to Dave Ramsey’s defense just a wee bit, he may not mention them in any books, but I’ve heard a lot about SEP-IRAs on his show and website –

    http://www.daveramsey.com/index.cfm?event=askdave/&intContentItemId=6247

    Seriously good stuff, I gotta keep up on your blog now :)

  • http://www.thisisaaronslife.com Aaron Irizarry

    Thanks for sharing this Whitney, great info that I am sure most people who own their own business, or work independently will find helpful.

  • http://twitter.com/erova Chris

    No doubt Whitney, they’re great. I have to remind myself that 25% of pretax income is a helluva lot more off the tax bill than writing off another business expense (even if a new camera or conference airfare is more fun).

    A few important things:
    1) To reiterate your point, you can make your contributions to your SEP plan until April 14, not December 31, so if your tax bill is uncomfortably high you can add more dough to your SEP and thus reduce the amount you owe to your Uncle Sam.
    2) if you ever hire any fulltime employees, they must have the same retirement plan (so if you start a hot new company tomorrow and need fulltime help, start it from scratch and don’t funnel it through whatever business structure you currently use). Then hire my dumbass. ;-)
    3) you can start one without the help of a financial advisor or broker on a self-service site like Vanguard.

  • http://www.uxbooth.com Matthew

    I am actually researching and investigating this very topic. Thanks for sharing :).

  • http://www.alonzofelix.com Alonzo Felix

    Thanks Whitney! This is just right.

  • Lee S

    Good advice for all freelancers! Actually, you can have a SEP at the same time as a regular IRA, since SEP contributions come from your employer (your corporation) and IRA contributions are personal, allowing you to save even more. You can also invest in any kind of fund in a SEP, and a target retirement date fund is a really easy way to not have to worry about your asset allocation.

  • David

    I was just going to say what Lee said. I have a SEP IRA and a Roth IRA, and I contribute the maximum to both. And I use a target retirement date fund for the same reason Lee said.

    So, basically, I guess I didn’t need to write this comment.

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