Self-Employed Can Consider These 401(k) Alternatives

If you’re a self-employed individual and don’t find setting up a 401(k) as your best option , you have other choices.

You can set up one of two types of IRAs – SEP and SIMPLE – to help you work toward your retirement savings goals.

“The IRS created these plans to help the self-employed get financially prepared for retirement,” said Joe Correnti, senior vice president of brokerage product at Scottrade. “They’re fairly simple to set up at brokerages, including Scottrade.”

And if you have employees, they can take advantage of SEP and SIMPLE IRAs as well. Let’s review SEP and SIMPLE.

Simplified Employee Pension (SEP) IRA

What is it? A SEP IRA allows employers of any size, as well as self-employed individuals, to contribute to a traditional IRA for either themselves (as the business owner) or for employees. In general, a business can contribute more to a SEP IRA than an individual would be allowed to make under a Traditional IRA.

Who is eligible? Generally, any business owner is eligible to set up and participate in a SEP IRA.

Employees must be allowed to participate in a SEP IRA if they meet the following criteria:

  • They are at least 21 years old.
  • They worked for your business in at least 3 of the last 5 years.
  • They received a minimum level of compensation for the year (see IRS website for more details).

Note: Employers are able to set less restrictive requirements than the ones above, but cannot establish more restrictive requirements.

How much can I contribute? You can contribute up to 25% of your yearly compensation up to a certain dollar amount (see IRS website for more details). If you have employees, you may be required to contribute an equal percentage of each eligible employee’s salary. However, contributions are discretionary, meaning you are not required to contribute each year. Employees do not make SEP contributions.

Taxes and withdrawals: SEP IRAs follow the same tax and withdrawals rules as Traditional IRAs. For more details, visit the IRS website.

Savings Incentive Match Plan for Employees (SIMPLE) IRA

What is it? SIMPLE IRAs are set up by small businesses (including self-employed individuals) with no more than 100 employees who earned at least $5,000 during the preceding calendar year. The full name of the plan – Savings Incentive Match Plan for Employees – offers a clue behind its primary purpose.

Who is eligible? There are a variety of rules, but as a starting point, employees who have received at least $5,000 in compensation during any preceding 2 years and are expected to receive at least $5,000 this year are usually able to participate. The IRS website contains more information regarding who is and isn’t eligible.

How much can I contribute? Any self-employed person or employee participating in a SIMPLE IRA may defer a designated amount of their compensation (see IRS website for more details). People ages 50 and over are eligible to defer an increased amount, known as a catch-up contribution.

If you have employees, you have two options:

  • Match employees’ salary deferrals dollar-for-dollar up to 3% of their compensation.
  • Contribute 2% of each employee’s salary as a non-elective contribution. Certain annual contribution limits will apply (see IRS website for more details).

Taxes and withdrawals: SIMPLE IRAs generally follow the same tax and withdrawals rules as Traditional IRAs. But there is an important exception for distributions received during the 2-year period after an employee first participates in the SIMPLE IRA. For more details, visit the IRS website.

Next step: Scottrade offers both SEP and SIMPLE IRAs. For more information about these and other plans, visit our Retirement center.

The information and content provided is for informational and/or educational purposes only.

Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.

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