Hi friends,
I recently started working as independant consultant. I never worked as a contractor before. I always had 401k from my employer. Right now I am on W2 with no benefits. So how can I contribute to tax deferred retirement savings? Any IT consultants out there who can suggest me the ways?
If there are any old threads with this topic please suggest.
thanks
Retirement Savings options for Consultants
Retirement Savings options for Consultants
You could open a SEP IRA with Vanguard or any reputed brokerage and could save upto 25% of employee's contribution or $44000 per annum whichever is less.
Retirement Savings options for Consultants
Thanks love inida for your reply.
Is it 25% of employee contribution or salary? please explain?
Is it 25% of employee contribution or salary? please explain?
Retirement Savings options for Consultants
Hi,
It is 25% of salary that can be contributed to a SEP IRA. You have until April 15 of the following year to make this contribution.
YRS
It is 25% of salary that can be contributed to a SEP IRA. You have until April 15 of the following year to make this contribution.
YRS
Retirement Savings options for Consultants
You may also consider Solo 401K. With this option, you can contribute 25% of salary as employer contribution + upto 15500 as employee contribution. Again the maximum of $44000 per annum holds here as well.
Retirement Savings options for Consultants
vanilla
You mentioned that you are a W2 consultant. I dont think you can participate in a SEP IRA. SEP IRA is for self employed individuals. You would have to be a CORP-CORP and not a W2. You need to have registered as a S-Corp or some type of proof to show that you are self employed. W2 means you are employed by some one.
I dont know abt Solo 401K option though.
HTH
You mentioned that you are a W2 consultant. I dont think you can participate in a SEP IRA. SEP IRA is for self employed individuals. You would have to be a CORP-CORP and not a W2. You need to have registered as a S-Corp or some type of proof to show that you are self employed. W2 means you are employed by some one.
I dont know abt Solo 401K option though.
HTH
-
FreeSpirit
- Posts: 148
- Joined: Fri Jan 26, 2007 10:01 pm
Retirement Savings options for Consultants
Even Solo 401K is for self employed only. Rules are same for SEP-IRA, Profit Sharing and Solo 401K.
-
puneri_punter
- Posts: 161
- Joined: Thu Feb 01, 2007 11:15 pm
Retirement Savings options for Consultants
vanilla,
To be very honest, you have decided the worst option (i.e. W2) for going independent consultant. You have the worst of both the worlds i.e. being an employee or being a consultant.
When you are on W2 you are an employee of that company period.
It doesn't matter what you call yourself or they call you. None of the tax advantages (deducting expenses) or retirement schemes are available to you.
To make matters worse, now that you are on W2 you cannot go Corp-to-Corp with the same company because of IRS rules. If you do that, you are guaranteed to get audited by IRS because IRS thinks you are doing this to avoid SS taxes. Goto the IRS website or google.
If you want to become a truly independent contractor you have only two options: start a S or C corp and do Corp-to-Corp OR
go 1099. 1099 is again a very short term option as it may trigger red flag at IRS.
Hope this helps.
To be very honest, you have decided the worst option (i.e. W2) for going independent consultant. You have the worst of both the worlds i.e. being an employee or being a consultant.
When you are on W2 you are an employee of that company period.
It doesn't matter what you call yourself or they call you. None of the tax advantages (deducting expenses) or retirement schemes are available to you.
To make matters worse, now that you are on W2 you cannot go Corp-to-Corp with the same company because of IRS rules. If you do that, you are guaranteed to get audited by IRS because IRS thinks you are doing this to avoid SS taxes. Goto the IRS website or google.
If you want to become a truly independent contractor you have only two options: start a S or C corp and do Corp-to-Corp OR
go 1099. 1099 is again a very short term option as it may trigger red flag at IRS.
Hope this helps.
Retirement Savings options for Consultants
You can do traditional IRA, upto 4k each for spouse and yourself that can get tax deductions and 2k each for children's education IRA where you can tax defer. For a family of two kids, that is 12k per year.
Retirement Savings options for Consultants
Please read this excellent article from MorningStar and choose the appropriate plan:
The entrepreneurial spirit is alive and well in America. And the government wants to sweeten the pot for the self-employed by giving out tax breaks that far exceed the average employee's maximum retirement contribution. As you may already know, the maximum amount anyone can contribute to a 401(k) plan is $15,500 ($20,500 if you are over age 50).
By using other types of retirement plans, self-employed individuals can sock away up to $45,000 in 2007. To do that, you'll need to know the ins and outs of the various retirement savings plans that you can use for this purpose. Details of all of these plans can be found in IRS Publication 560.
Tax Incentives for Setting Up a Plan
Thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, if you set up a retirement plan after Dec. 31, 2001, you may be eligible for a tax credit for 50% of the cost of setting up the plan and educating your employees. The maximum credit is $500 per year for up to three years.
Choosing the Right Self-Employed Retirement Plan
SEP (Simplified Employee Pension) Plan
The Basics: A retirement plan that uses an IRA as a funding vehicle.
How to Set It Up: Either you or your employee opens an account with a fund company, brokerage, bank, or other financial institution. You have until the due date of your tax return (including extensions) to set up accounts that you can contribute to in the current tax year.
Contribution Limits: In 2007, the employer can contribute up to the lesser of 25% of employee compensation (up to a compensation maximum of $225,00 for 2007) or $45,000 to each participant account. The employer can deduct a maximum of 25% of the total compensation paid or accrued during the year to eligible participants in the plan. The employee can also contribute subject to the regular rules regarding IRAs (including catch-up contributions). As an employer, you are not required to make a contribution every year. When you do make a contribution, you can't discriminate in favor of highly compensated employees.
Pros:
? Easy and cost-efficient to set up and maintain.
? Annual employer contributions are discretionary.
? No annual IRS forms to file.
? Contributions can be made after plan year-end (up until tax-filing deadline).
? Employees have investment responsibility for their own accounts.
Cons:
? Plan must cover all employees, even part-time employees.
? No loans allowed.
? Employer can't contribute as much as other plans allow.
Profit Sharing Plan
The Basics: A qualified retirement plan that allows an employer to make flexible, discretionary contributions on behalf of employees.
How to Set It Up: You need a written plan, which you can get from an outside administrator, or you can adopt a prototype plan at most mutual fund companies, banks, or brokerages. The plan has to be in place by the end of the calendar year for you to make contributions to it for that tax year.
Contribution Limits: The employer can contribute up to 100% of compensation (up to a max of $225,000 for 2007) or $45,000 for 2007-- whichever is less--to each participant account. The employer can deduct a maximum of 25% of the total compensation paid or accrued during the year to eligible participants in the plan. Employees cannot make their own contributions to the plan.
Pros:
? Flexible employer contributions--you don't have to contribute every year.
? Employees have investment responsibility for their own accounts.
Cons:
? More filing requirements for employer than other plans.
? No employee contributions.
? Plan has to be set up by the end of the calendar year.
? Employer can't contribute as much as other plans allow.
Money Purchase Plan
The Basics: A qualified plan that sets a fixed percentage contribution that must be met every year.
How to Set It Up: You need a written plan which you can get from an outside administrator, or you can adopt a prototype plan at most mutual fund companies, banks, or brokerages. The plan has to be in place by the end of the calendar year for you to make contributions to it for that tax year..
Contribution Limits: The employer can contribute up to 100% of compensation (up to a max of $225,000 for 2007) or $45,000 for 2007--whichever is less--to each participant account. The employer can deduct a maximum of 25% of the total compensation paid or accrued during the year to eligible participants in the plan. Employees cannot make their own contributions to the plan.
Pros: There's little reason to set up this type of plan anymore. It used to be that you needed this plan (paired with a Profit Sharing Plan) to be able to get to a 25% contribution of compensation. Since EGTRRA, you can get to 25% with just a Profit Sharing Plan or a SEP-IRA.
Cons:
? Required employer contributions, i.e. once you set your contribution percentage, you must make contributions.
? More filing requirements for employer than other plans.
? No employee funding.
? Employer can't contribute as much as other plans allow.
401(k) Plan
The Basics: A qualified retirement plan that allows for salary deductions for employees (salary-deferral) and matching contributions from employers. If you are both the employee and employer, you can set up a one-person 401(k) and contribute as both the employee and employer.
How to Set It Up: Traditional third-party plan administrators can design a plan or you can go to one of the newer online providers such as Fidelity's e401(k).
Contribution Limits: Employees can defer up to $15,500 in 2007, with an additional catch-up contribution of $5,000 if they are over age 50. The employer may match a portion of the employee contribution. The match is in addition to the employee contribution, so for example, if you contribute $20,500 in 2007, your employer can add a match on top of that.
Pros:
? Employees contribute part of their salary.
? Less financial burden on the employer than other plans.
? Employer can offer other features, such as employee loans.
? Employees have investment responsibility for their own accounts.
Cons:
? More administrative work than other plans.
? More expensive to set up than other plans.
? Employer can't contribute as much as other plans allow.
Paired Profit Sharing and 401(k) Plan
The Basics: This is a profit sharing plan combined with an elective salary deferral, or 401(k), plan. The employer makes the profit sharing contributions. Employees can defer part of their salaries into a 401(k) plan. Employers also can choose to match part of the employee salary deferral.
How to Set It Up: See rules for Profit Sharing and 401(k) plans above.
Contribution Limits: Employer contributions can go up to the lesser of 100% of compensation (up to a max of $225,000 for 2007) or $45,000 for 2007. The employee can put up to $15,500 into the plan ($20,500 if participant is over age 50), but the total contributions (both employer and employee) cannot exceed $45,000 plus catch-up contributions.
Pros:
? Allows employees to make contributions through salary deferral, or 401(k), and allows employers to make contributions to the Profit Sharing Plan.
? Employees have investment responsibility for their own accounts.
Cons:
? More administrative work by combining the plans.
? More expense in having two plans.
? Employer can't contribute as much as other plans allow.
SIMPLE (Savings Incentive Match Plan for Employees) Plan
The Basics: A retirement plan available to employers with 100 or fewer employees who received $5,000 or more in compensation for the preceding year. Employees contribute using salary deferral. Employers must contribute a match for all eligible employees.
Set It Up: There are two types of SIMPLE plans: SIMPLE IRAs and SIMPLE 401(k)s. Use IRS Form 5304-SIMPLE or 5305-SIMPLE to set up a plan. Most people set up the SIMPLE IRA because it is less expensive to maintain and has fewer reporting requirements.
Contribution Limits: Employees can contribute up to 100% of compensation up to a maximum of $10,500 for 2007. Employees can also make catch-up contributions of $2,500 for 2007. Employers must match contributions from 1% to 3% of compensation.
Pros:
? Minimal reporting requirements for the employer.
? Works well in companies where salaries are relatively low.
? Inexpensive to set up and maintain.
? Employees have investment responsibility for their own accounts.
Cons: Employer can't contribute as much as other plans allow.
Pension (Defined Benefit) Plan
The Basics: A qualified retirement plan where the employer makes contributions based on an actuarial formula. Employer has funding and investment responsibility for the plan.
How to Set It Up: First you adopt a written plan. Then your administrator figures out how much you should contribute each year. The plan must be in place by the end of the calendar year for you to be able to make contributions to it for that tax year. The employer chooses how this money is invested within a trust or custodial account.
Contribution Limits: The employer contributes the actuarially determined amount to provide a benefit that's the lesser of 100% of the participant's average compensation (not to exceed $225,000 for 2007) for his or her highest-paid three consecutive calendar years, or $180,000 for 2007. You must make quarterly installment payments subject to minimum funding requirements.
Pros: Employers can put away more money for employees than in other plans.
Cons:
? More expensive to set up and maintain than other plans.
? More administrative burden than other plans.
? Employer is responsible for investment choices.
Paired Defined Benefit and Defined Contribution Plan
The Basics: A combination of a pension plan (defined-benefit) and a 401(k) or profit-sharing plan (or other types of defined contribution plans).
How to Set It Up: See notes for each type of plan.
Contribution Limits: If you contribute to both a defined benefit plan and a defined contribution plan, your deduction is limited to the greater of 25% of compensation paid (for the defined contribution plan) or no more than the amount needed to meet the year's minimum funding standard (for the defined benefit plan). If you are self-employed, the rules are even more complicated (see IRS Publication 560).
Pros: Allows maximum contributions.
Cons:
? Expensive to set up and maintain.
? More administrative burden than other plans.
Note: If you are considering this type of plan arrangement, you should also consider a cross-tested defined benefit cash balance plan (which is beyond the scope of this article).
The entrepreneurial spirit is alive and well in America. And the government wants to sweeten the pot for the self-employed by giving out tax breaks that far exceed the average employee's maximum retirement contribution. As you may already know, the maximum amount anyone can contribute to a 401(k) plan is $15,500 ($20,500 if you are over age 50).
By using other types of retirement plans, self-employed individuals can sock away up to $45,000 in 2007. To do that, you'll need to know the ins and outs of the various retirement savings plans that you can use for this purpose. Details of all of these plans can be found in IRS Publication 560.
Tax Incentives for Setting Up a Plan
Thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, if you set up a retirement plan after Dec. 31, 2001, you may be eligible for a tax credit for 50% of the cost of setting up the plan and educating your employees. The maximum credit is $500 per year for up to three years.
Choosing the Right Self-Employed Retirement Plan
SEP (Simplified Employee Pension) Plan
The Basics: A retirement plan that uses an IRA as a funding vehicle.
How to Set It Up: Either you or your employee opens an account with a fund company, brokerage, bank, or other financial institution. You have until the due date of your tax return (including extensions) to set up accounts that you can contribute to in the current tax year.
Contribution Limits: In 2007, the employer can contribute up to the lesser of 25% of employee compensation (up to a compensation maximum of $225,00 for 2007) or $45,000 to each participant account. The employer can deduct a maximum of 25% of the total compensation paid or accrued during the year to eligible participants in the plan. The employee can also contribute subject to the regular rules regarding IRAs (including catch-up contributions). As an employer, you are not required to make a contribution every year. When you do make a contribution, you can't discriminate in favor of highly compensated employees.
Pros:
? Easy and cost-efficient to set up and maintain.
? Annual employer contributions are discretionary.
? No annual IRS forms to file.
? Contributions can be made after plan year-end (up until tax-filing deadline).
? Employees have investment responsibility for their own accounts.
Cons:
? Plan must cover all employees, even part-time employees.
? No loans allowed.
? Employer can't contribute as much as other plans allow.
Profit Sharing Plan
The Basics: A qualified retirement plan that allows an employer to make flexible, discretionary contributions on behalf of employees.
How to Set It Up: You need a written plan, which you can get from an outside administrator, or you can adopt a prototype plan at most mutual fund companies, banks, or brokerages. The plan has to be in place by the end of the calendar year for you to make contributions to it for that tax year.
Contribution Limits: The employer can contribute up to 100% of compensation (up to a max of $225,000 for 2007) or $45,000 for 2007-- whichever is less--to each participant account. The employer can deduct a maximum of 25% of the total compensation paid or accrued during the year to eligible participants in the plan. Employees cannot make their own contributions to the plan.
Pros:
? Flexible employer contributions--you don't have to contribute every year.
? Employees have investment responsibility for their own accounts.
Cons:
? More filing requirements for employer than other plans.
? No employee contributions.
? Plan has to be set up by the end of the calendar year.
? Employer can't contribute as much as other plans allow.
Money Purchase Plan
The Basics: A qualified plan that sets a fixed percentage contribution that must be met every year.
How to Set It Up: You need a written plan which you can get from an outside administrator, or you can adopt a prototype plan at most mutual fund companies, banks, or brokerages. The plan has to be in place by the end of the calendar year for you to make contributions to it for that tax year..
Contribution Limits: The employer can contribute up to 100% of compensation (up to a max of $225,000 for 2007) or $45,000 for 2007--whichever is less--to each participant account. The employer can deduct a maximum of 25% of the total compensation paid or accrued during the year to eligible participants in the plan. Employees cannot make their own contributions to the plan.
Pros: There's little reason to set up this type of plan anymore. It used to be that you needed this plan (paired with a Profit Sharing Plan) to be able to get to a 25% contribution of compensation. Since EGTRRA, you can get to 25% with just a Profit Sharing Plan or a SEP-IRA.
Cons:
? Required employer contributions, i.e. once you set your contribution percentage, you must make contributions.
? More filing requirements for employer than other plans.
? No employee funding.
? Employer can't contribute as much as other plans allow.
401(k) Plan
The Basics: A qualified retirement plan that allows for salary deductions for employees (salary-deferral) and matching contributions from employers. If you are both the employee and employer, you can set up a one-person 401(k) and contribute as both the employee and employer.
How to Set It Up: Traditional third-party plan administrators can design a plan or you can go to one of the newer online providers such as Fidelity's e401(k).
Contribution Limits: Employees can defer up to $15,500 in 2007, with an additional catch-up contribution of $5,000 if they are over age 50. The employer may match a portion of the employee contribution. The match is in addition to the employee contribution, so for example, if you contribute $20,500 in 2007, your employer can add a match on top of that.
Pros:
? Employees contribute part of their salary.
? Less financial burden on the employer than other plans.
? Employer can offer other features, such as employee loans.
? Employees have investment responsibility for their own accounts.
Cons:
? More administrative work than other plans.
? More expensive to set up than other plans.
? Employer can't contribute as much as other plans allow.
Paired Profit Sharing and 401(k) Plan
The Basics: This is a profit sharing plan combined with an elective salary deferral, or 401(k), plan. The employer makes the profit sharing contributions. Employees can defer part of their salaries into a 401(k) plan. Employers also can choose to match part of the employee salary deferral.
How to Set It Up: See rules for Profit Sharing and 401(k) plans above.
Contribution Limits: Employer contributions can go up to the lesser of 100% of compensation (up to a max of $225,000 for 2007) or $45,000 for 2007. The employee can put up to $15,500 into the plan ($20,500 if participant is over age 50), but the total contributions (both employer and employee) cannot exceed $45,000 plus catch-up contributions.
Pros:
? Allows employees to make contributions through salary deferral, or 401(k), and allows employers to make contributions to the Profit Sharing Plan.
? Employees have investment responsibility for their own accounts.
Cons:
? More administrative work by combining the plans.
? More expense in having two plans.
? Employer can't contribute as much as other plans allow.
SIMPLE (Savings Incentive Match Plan for Employees) Plan
The Basics: A retirement plan available to employers with 100 or fewer employees who received $5,000 or more in compensation for the preceding year. Employees contribute using salary deferral. Employers must contribute a match for all eligible employees.
Set It Up: There are two types of SIMPLE plans: SIMPLE IRAs and SIMPLE 401(k)s. Use IRS Form 5304-SIMPLE or 5305-SIMPLE to set up a plan. Most people set up the SIMPLE IRA because it is less expensive to maintain and has fewer reporting requirements.
Contribution Limits: Employees can contribute up to 100% of compensation up to a maximum of $10,500 for 2007. Employees can also make catch-up contributions of $2,500 for 2007. Employers must match contributions from 1% to 3% of compensation.
Pros:
? Minimal reporting requirements for the employer.
? Works well in companies where salaries are relatively low.
? Inexpensive to set up and maintain.
? Employees have investment responsibility for their own accounts.
Cons: Employer can't contribute as much as other plans allow.
Pension (Defined Benefit) Plan
The Basics: A qualified retirement plan where the employer makes contributions based on an actuarial formula. Employer has funding and investment responsibility for the plan.
How to Set It Up: First you adopt a written plan. Then your administrator figures out how much you should contribute each year. The plan must be in place by the end of the calendar year for you to be able to make contributions to it for that tax year. The employer chooses how this money is invested within a trust or custodial account.
Contribution Limits: The employer contributes the actuarially determined amount to provide a benefit that's the lesser of 100% of the participant's average compensation (not to exceed $225,000 for 2007) for his or her highest-paid three consecutive calendar years, or $180,000 for 2007. You must make quarterly installment payments subject to minimum funding requirements.
Pros: Employers can put away more money for employees than in other plans.
Cons:
? More expensive to set up and maintain than other plans.
? More administrative burden than other plans.
? Employer is responsible for investment choices.
Paired Defined Benefit and Defined Contribution Plan
The Basics: A combination of a pension plan (defined-benefit) and a 401(k) or profit-sharing plan (or other types of defined contribution plans).
How to Set It Up: See notes for each type of plan.
Contribution Limits: If you contribute to both a defined benefit plan and a defined contribution plan, your deduction is limited to the greater of 25% of compensation paid (for the defined contribution plan) or no more than the amount needed to meet the year's minimum funding standard (for the defined benefit plan). If you are self-employed, the rules are even more complicated (see IRS Publication 560).
Pros: Allows maximum contributions.
Cons:
? Expensive to set up and maintain.
? More administrative burden than other plans.
Note: If you are considering this type of plan arrangement, you should also consider a cross-tested defined benefit cash balance plan (which is beyond the scope of this article).