The Best IRAs for the Self-Employed
Choice is one of the most-prized benefits of being self-employed. Besides the obvious choices of how, when and where to work, are a number of more subtle options, such as control of income and career path. The choice of retirement savings plan is also a less-heralded, but significant decision, as there are several IRA plans designed specifically for small businesses. Choosing the best IRA is about understanding both your business, and your long term goals.
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Types of IRA Plans
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Two types of IRAs are designed specifically for the self-employed, or small employer: the SEP (Simplified Employee Pension) and the SIMPLE (Savings Incentive Match Plan for Employees). In addition, self-employed people can have individual traditional or Roth IRAs. With an SEP IRA, you make contributions as an employer only, whereas SIMPLE IRAs allow contributions both as employer and employee. Individual IRAs are solely individual contributions.
Contribution Limits
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SEP IRAs allow contributions up to the lesser of 20 percent of income, or $49,000 per year, as of 2010. The SIMPLE IRA requires one of two designs: an employer match of 3 percent of employee elective contributions, or a flat 2 percent of income, non-elective contribution. Employee elective contributions must not exceed $11,500 in 2010, and non-elective contributions cannot exceed $4,900 in 2010. Provided SIMPLE IRA contributions are always salary-deferral contributions, neither plan limits additional contributions to an individual IRA -- up to $5,000 in 2010.
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Considerations
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One of the biggest factors in choosing an IRA plan is the ability to save, but larger deferral limits are only beneficial if your budget allows large contributions. SEP and SIMPLE plans may also have higher administrative costs that offset the higher contribution limits, if savings ability is limited. In addition, SEP and SIMPLE plans must be extended to include additional employees. This is a potential benefit if it's used to attract and retain talented workers, but can be restrictive if money is tight.
Diversification
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Those who want to diversify their future tax burden, and have more than the individual IRA maximum to save, should consider both a SEP or SIMPLE plan and an individual Roth IRA. SEP and SIMPLE plans are both pre-tax, traditional IRAs, meaning that money is taxed in retirement with required distributions. A Roth IRA contribution is taxable now, but contributions and income may be withdrawn tax-free in retirement, and distributions are not required.
Recommendations
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Many self-employed people who don't have employees will find that an SEP IRA, with or without an additional Roth IRA, is the best option. The SEP IRA allows contribution flexibility from year to year, and typically has lower administrative costs. It allows the highest possible contribution and doesn't restrict additional contributions to individual IRAs.
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