Retirement Plans for the Sole Proprietor
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In business for yourself? Here's what you need to know about your retirement plan options.

If you are self-employed, you may not have taken the time to think about saving for your own retirement.

Maybe you've made some contributions to an IRA account or you've rolled over that balance you had in a former employer's 401(k) plan when you made the move to venture out on your own.

A traditional 401(k) plan may be too expensive and complicated for a sole proprietor, and end up being far more plan than you need. That doesn't mean that an IRA is your only option.

"There are alternatives available to sole proprietors," says Rich Linton, Managing Director, Business Retirement Solutions. "Take the time to consider a workplace retirement plan such as a Simplified Employee Pension (SEP) IRA plan or a Savings Incentive Match Plan for Employees (SIMPLE) IRA plan."

"Whatever your personal perspective, the reality is that you need to take the time now to plan for your own retirement. No one is going to do it for you," says Linton. "You're not only an employer, you're an employee of your business. Benefits are no less crucial to you than they are to any employee working for a large corporation."

Setting up a retirement plan takes time, money and a fair amount of administrative work – all of which can be in short supply for small businesses owners. Choosing a retirement plan is a crucial step for the self-employed. Congress made the SEP IRA and SIMPLE IRA plans available to make it easy for self-employed taxpayers to save for retirement.

Here's How They Work

Simplified Employee Pension (SEP) IRA: Relatively easy to open and inexpensive to maintain, SEP IRAs allow a sole proprietor to contribute annually a hefty 20% of "net earnings from self-employment," up to a $49,000 cap, in 2011. Contribution levels can be changed from year to year, accommodating fluctuating income and business liquidity needs. Linton says, "You can have a great year and contribute 20% and then the next year lower that contribution to 5% or even cease contributing."

A SEP IRA holder can withdraw funds at any time. Withdrawals are subject to income tax and may be subject to a 10% additional tax for anyone under age 59½. There are exceptions under special circumstances, such as the purchase of a first home or medical expenses.

While a SEP IRA is best suited for a sole proprietor with no employees, if you do have employees, you'll have to include them as well. They will set up IRAs under your SEP IRA plan and you'll make contributions to those IRAs. Contributions are limited to 25% of their compensation, with a $49,000 cap in 2011. "You may deduct the contributions as a business expense on your tax return,"1 says Linton.

The bottom line: A SEP IRA is appropriate for sole proprietors who don't want to or aren't able to save more than $49,000 a year and who may want to vary or even skip contributions from year to year.

Simplified Matching Plan for Employees (SIMPLE) IRA: Available to small businesses (i) with 100 or fewer employees who received at least $5000 of compensation for the preceding year and (ii) that do not maintain another employer-sponsored plan to which contributions were made or benefits accrued, SIMPLE IRAs can also be appropriate for a sole proprietor who intends to hire employees and provide them with a retirement plan in the future.

"A SIMPLE IRA is similar to a 401(k) plan but even easier to administer and less costly", says Linton. It allows the business owner, as well as employees under age 50, to defer as much as $11,500 of their annual salary in 2011. Those 50 and older can contribute an additional $2,500 in 2011. Employers must also choose an employer contribution formula. This can be either a dollar-for-dollar match of the employee's contribution, up to 3% of the employee's annual compensation, or a straight 2% of the employee's annual compensation, regardless of the employee's participation in the plan, taking into account a maximum of $245,000 in compensation in 2011. Linton adds, "The SIMPLE IRA requires employer contributions. If your business has variable cash flows, this might not be the right plan for you. Withdrawals are subject to ordinary income tax, and withdrawals made before age 59½ may be subject to an additional federal tax – 25% on funds withdrawn within two years of the first contribution and 10% on contributions withdrawn after two years." Certain exceptions to both the 25% additional tax and the 10% additional tax may apply.

The bottom line: A SIMPLE IRA may be a good choice for business owners who plan to hire employees and who want to provide a retirement plan in which the employees also make contributions toward their retirement.

Get credit for start-up costs: A tax credit generally is available for plan start-up costs incurred for the first three years of your plan. You may be able to claim a tax credit for at least part of the ordinary and necessary costs of starting a SEP, SIMPLE, or qualified plan. The credit equals 50% of the cost to set up and administer the plan and educate employees about the plan, up to a maximum of $500 per year for each of the first 3 years of the plan. (Note that a tax deduction will not be allowed for that portion of the qualified start-up costs paid or incurred for the year that is equal to the credit allowed to be claimed.)

To claim the credit, use IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs. For more information on this credit, see IRS Publication 560, Retirement Plans for Small Businesses.

Take the Next Step with Merrill Edge

A SEP IRA or a SIMPLE IRA may be just what you need to get started on building your own retirement nest egg. Learn more about how a small business IRA might be right for you.

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1 See IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) for more information regarding tax deductions, contribution limits, etc. This publication is available at

Merrill Edge and its Financial Solutions Advisors do not provide tax, accounting or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein.