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10. Financial Fitness for the Self-Employed

What To Do If You Can't Join an Employer-Based Plan

You may not be able to join an employer-based retirement plan because you are not eligible or because the employer doesn't offer one. Fortunately, there are steps you can still take to build your retirement strength.

Take a job with a plan. If two jobs offer similar pay and working conditions, the job that offers retirement benefits may be the better choice.

Start your own plan. If you can't join a company plan, you can save on your own.

You can't put away as much on a tax-deferred basis, and you won't have an employer match. Still, you can build a healthy nest egg if you work at it.

Retirement Planning for Employees in Small Companies

If you don't have a plan available at work, encourage your employer to start one. Many small employers believe their workers prefer higher salaries or other benefits, and they believe the rules are too complex and the costs too high.

Mention the following benefits:

A retirement plan can attract and retain valued employees in a competitive labor market, as well as motivate workers.
Establishing a retirement plan and encouraging employee participation can help employers fund their own retirement. Even after taking into account the cost of establishing an employee plan, employers may still be better off than funding retirement on their own.
Some plans cost less and have fewer administrative hassles than employers may realize. Alternatives to traditional defined benefit plans and the 401(k) include the SIMPLE and the SEP.

For more information, contact EBSA at 1-866-444-3272 and request Choosing a Retirement Solution for Your Small Business, SIMPLE IRA Plans for Small Businesses, SEP Retirement Plans for Small Businesses, and 401(k) Plans for Small Businesses.

Open an IRA. You can put up to $4,000 a year into an individual retirement account on a tax-deductible basis if your spouse isn't covered by a retirement plan at work, or as long as your combined incomes aren't too high. This amount remains the same through 2007 and will increase in 2008 to $5,000. Persons who are 50 or older can contribute an additional $1000. You also can put the same amount tax- deferred into an IRA for a nonworking spouse if you file your income tax return jointly. (By the way, you don't have to put in the full amount; you can put in less.) With a traditional IRA, you delay income taxes on what you put in and on the earnings until you withdraw the money. With a Roth IRA, the money you put in is already taxed, but you won't ever pay income taxes on the earnings as long as the account is open at least 5 years.

Consider an annuity. An annuity is when you pay money to an insurance company in return for its agreement to pay either a regular fixed amount when you retire or an amount based on how much your investment earns. There is no limit on how much you can invest in a private annuity, and earnings aren't taxed until you withdraw them. However, annuities present complex issues regarding taxes, fees, and withdrawal strategies that may not make them the best investment choice for you. Consider discussing this type of investment first with a financial planner.

Build your personal savings. You can always save money on your own, either in mutual funds, stocks, bonds (such as U.S. Savings Bonds), real estate, CDs, or other assets. It's best to mark these investments as part of your retirement fund and don't use them for anything else unless absolutely necessary.

Investing in an IRA, an annuity, or in personal savings means you are totally responsible for directing your own investments. How conservatively or aggressively you invest is up to you. It will depend in part on how willing you are to take investment risks, your age, the stability of your job, and other financial needs. Learn as much as you can about investing and about specific investments you are considering. You also may want to seek the help of a professional financial planner. Go to www.CFP.net/learn for tips on choosing a financial planner who puts your interests first.

What To Do If You Are Self-Employed

Many people today work for themselves, either fulltime or in addition to their regular job. They have several tax-deferred options from which to choose.

SEP. This is the same type of SEP described earlier under employer-based retirement plans. Only here, you're the employer and you fund the SEP from your earnings. You can easily set up a SEP through a bank, mutual fund, or other financial institution.

"Keogh". "Keoghs" are more complicated to set up and maintain, but they offer more advantages than a SEP. For one thing, they come in several varieties. Some of the varieties allow you to sock away more money - sometimes a lot more money - than a SEP.

SIMPLE IRA. Described earlier under employer-based retirement plans, a SIMPLE IRA can be used by the self-employed. However, generally you can't save as much as you can with a SEP or "Keogh".

IRA. Usually you are better off funding a SEP or a "Keogh" unless your self-employment income is small.

Annuities. See annuities under the section on What to Do if You Can't Join an Employer-Based Plan.

CAUTION

Don't borrow from your retirement plan or permanently withdraw funds before retirement unless absolutely necessary.
Your retirement plan may allow you to borrow from your account, often at very attractive rates. However, borrowing reduces the accounts earnings, leaving you with a smaller nest egg. Also, if you fail to pay back the loan, you could end up paying income taxes and penalties. As an alternative, consider budgeting to save the needed money or pursue other affordable loan options.
Also avoid permanently withdrawing funds before retirement. This often happens when people change jobs. According to a study by the Employee Benefits Research Institute, only 47 percent of workers changing jobs rolled over into an IRA or a new employer's retirement plan, at least some of the money they received from their former employer's retirement plan.
Pre-retirement withdrawals reduce the ultimate size of your nest egg. In addition, you'll probably pay federal income taxes on the amount you withdraw (10 percent to as high as 39.1 percent) and a 10 percent penalty may be tacked on if you're younger than age 59-1/2. In addition, you may have to pay state taxes. If you're in a SIMPLE IRA plan, that early withdrawal penalty climbs to 25 percent if you take out money during the first 2 years you're in the plan.

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