by Jared Lewis
Self-employed small-business owners need to plan and save for retirement just like everyone else. Doing so requires that you put away enough money to account for your retirement needs, but the problem is often in determining how much that is. The problem is further compounded by the fact that there are different retirement plans available to self-employed business owners — and each has its own limits concerning contributions.
1. Examine the various retirement-plan options at your disposal. Four primary types of accounts exist for self-employed individuals. Each has its own merits and maximum allowable contributions. The Simple IRA, SEP IRA, Solo 401(k) and the Defined Benefit Plan are the four major types of accounts available. Of these, the Simple IRA, SEP IRA and Solo 401(k) are most likely to be appropriate for most small-business owners.The Defined Benefit Plan should only be used if you have or will have a significant amount of money to save for retirement. This plan has a maximum allowable annual contribution limit of $195,000, as of 2011.
2. Create a budget to determine how much money you can save toward retirement each month. This can be a significant challenge in and of itself, because you have to take into account fixed and variable business expenses and have a good feel for how much excess cash you have that goes directly in your pocket each month. Create your budget based on the personal income you take away from your business.
3. Set a goal to save a percentage of your money each month and stick with it. The more you commit to saving, the better. If you don’t realistically know how much you can set aside, set a minimum goal of 10 percent of your income, and shoot for a higher number. A goal between 10 and 50 percent is likely to be doable for most small-business owners. Determine which end of that spectrum best fits your ability to save, and begin putting that much money away each month.
4. Determine the retirement plan that best meets your needs as a small-business owner. You can choose your plan based on any number of different criteria such as how and when they’re taxed. Since you’re trying to determine an amount to save, consider choosing a plan based on the contribution limits. This will help you determine how much of your own money to save. A Simple IRA has a contribution limit of $11,500 for self-contributions, while the SEP IRA allows up to $49,000 to be put away. The Solo 401(k) allows up to $49,000 also, but comes with the option of a $16,500 salary deferral before taxes, plus an additional 25 percent of income.
5. Divide the maximum contribution allowed by the plan you choose by 12 — to determine what you would need to put away each month to reach the maximum amount. Compare this number to your original goal. If it’s lower than your goal, either choose a different plan or open multiple retirement accounts. If it’s higher than your goal, raise your goal or use your goal and the maximum allowable limit as a range of savings to shoot for each month. This will give you the ability to adjust your savings as your finances allow.