Retirement and the Self-Employed

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	Retirement and the Self-Employed Personal Finance Advisor by Deloitte & Touche OnLine March 30, 1998

There are options, and they're a great last-minute tax planning tool.

It is not too late for individuals who earned self-employment income in 1997 to defer taxes on at least part of that income. According to the Department of Labor, there are approximately 9 million self-employed individuals in the United States. Taxpayers with wage income may also have self-employment income (for example, director fees, executor fees, consulting fees). Many of these taxpayers fail to take advantage of retirement savings accounts that permit deferral of taxes on self-employment income.

In addition to Individual Retirement Accounts (IRAs), there are three basic types of retirement savings accounts that self-employed individuals should consider -- Simplified Employee Pension Plans (SEP Plans), Keogh Plans, and Savings Incentive Match Plans for Employees (SIMPLE Plans). The following discussion is applicable to self-employed individuals who do not employ other workers in their business (that is, sole proprietors).

SEP Plans: Under these plans, a self-employed individual can make contributions to an individual retirement account, known as an SEP-IRA. Most financial institutions will establish an SEP-IRA using IRS-approved prototype plan documents. Administrative costs are low because the IRS does not impose annual filing requirements on SEP-IRAs. Additionally, SEP-IRA contributions can be made even if the individual participates in an employer’s qualified retirement plan.

Annual contributions to an SEP-IRA are discretionary (that is, the taxpayer is not required to make a contribution each year). The account must be established and contributions must be made before the due date of the individual’s tax return (including extensions). The maximum contribution is 13.0435% of net self-employment income. Net self-employment income is defined as self-employment income less related expenses and 50% of the self-employment tax paid. For 1997, net self-employment income in excess of $184,000 cannot be considered when determining the maximum contribution to an SEP-IRA.

Example: A taxpayer had net self-employment income of $200,000 during 1997. The maximum contribution that can be made to an SEP-IRA is $24,000 ($184,000 x 13.0435%). If the taxpayer's marginal tax rate is 36%, the $24,000 contribution defers approximately $8,600 of tax. Additionally, earnings in the SEP-IRA are tax-free until withdrawn.

Keogh Plans: To make contributions for 1997, a Keogh plan must have been set up by December 31, 1997. Administration of a Keogh is usually more complex than an SEP-IRA -- when plan assets exceed $100,000, the IRS imposes annual filing requirements. A Keogh is a qualified retirement plan, and there are two basic types of plans -- defined contribution and defined benefit plans.

As a general rule, defined contribution plans are either profit sharing arrangements or money purchase plans. Annual contributions to a profit sharing plan are not mandatory, and maximum deductible contributions are deductible up to 13.0435% of net self-employment income (not exceeding $184,000). Annual contributions to a money purchase plan are mandatory -- the maximum is the lesser of $30,000, or a fixed percentage (up to 20%) of self-employment income. If annual contributions are not made to the money purchase plan, an excise tax is imposed.

A profit sharing plan (or SEP-IRA) can be combined with a money purchase plan. A combination plan provides the maximum allowable annual contribution (20% of self-employment income), while allowing flexibility for the discretionary portion of the contribution (for example, 13.0435% could be contributed on a discretionary basis to an SEP-IRA, with the remaining amount being a fixed contribution to a money purchase plan).

Under a defined benefit plan, a fixed benefit will be paid from the plan in the future. Contributions to defined benefit plans are based on an actuarially determined amount designed to provide sufficient funds for the fixed benefit at a specified retirement age. For 1997, the annual benefit at retirement cannot exceed the lesser of $125,000, or the average of the participant’s earned income for the three consecutive highest years.

SIMPLE Plans: A self-employed person could establish a SIMPLE-IRA, for which the IRS provides model plan documents. To make contributions to a SIMPLE-IRA for 1997, the plan must have been set up before self-employment income was earned. The maximum annual contribution to a SIMPLE-IRA is $12,000, or total compensation, if less (the maximum contribution will be lower if net self-employment income is less than $200,000). In some cases, the maximum contribution allowed for a SIMPLE-IRA would be more than the maximum allowed under an SEP or Keogh plan -- the elective contribution to a SIMPLE-IRA is limited by the amount of the taxpayer’s income, while both the SEP and Keogh contributions are limited by a percentage of income.

Summary: The following chart summarizes key aspects of tax-deferred retirement savings accounts that are available to self-employed individuals.

Type of plan	Due Date of Contributions	Maximum annual contribution
IRA	April 15, 1998	Lesser of taxable compensation, or $2,000
SEP-IRA	Due Date of Tax Return (including extensions)	13.0435% of net self-employment income not exceeding $184,000
Simple-IRA	Due Date of Tax Return (including extensions)	$12,000, or total compensation, if less.
Keogh	Due Date of Tax Return (including extensions)	Defined Contribution Plan: Lesser of $30,000, or 20 percent of Self-Employment Income. Defined Benefit Plan: Actuarially Determined Amount to Provide for Fixed Future Benefit (which cannot exceed $125,000, or the average of earned income for the three consecutive highest years).

These are some thoughts to consider about tax-deferred retirement savings plans available to self-employed individuals. Your Deloitte & Touche financial and tax advisors can provide additional information and should be consulted before any action is taken.