Retirement plan options abound for independent contractors

Nearly 13 percent of the U.S. workforce is now made up of independent contractors, according to recent estimates. And though these workers might not have access to many traditional employer-provided benefits like health and disability insurance, they still have good options when it comes to saving for retirement.

While many full-time employees participate in their companies' 401(k) plans, independent contractors have a number of alternative retirement plans available. Here are some key aspects of each type of plan.

If you are a solo independent contractor, the SIMPLE IRA (Savings Incentive Match Plan for Employees) lives up to its name. You can contribute $12,500 per year, or $15,500 if you are older than 50. These contributions are made in pretax dollars, which helps to manage your tax bill, and the limit far exceeds the $5,500 ($6,500 including catch-up contributions) you can park in a traditional individual retirement account each year.

If you have employees, things get a little more complicated. You are required to follow one of two approaches in terms of employer contributions:

1. Match each employee's salary deferral contribution on a dollar-for-dollar basis up to 3 percent of his or her salary.

2. Make nonelective contributions of 2 percent of each employee's salary to each employee's plan, whether he or she chooses to contribute to the plan or not.

The big advantage of the SEP-IRA (Simplified Employee Pension plan) is the high contribution limit. You can contribute up to 25 percent of your pay, up to a maximum contribution limit of $53,000 a year. Once again, this is great news from a tax perspective, because contributions are made in pretax dollars. However, elective salary deferrals and catch-up contributions are not permitted in SEP plans.

Solo 401(k)s, or one-participant 401(k) plans, allow you to quickly make big contributions. You can defer your first $18,000 ($24,000 if you are older than 50) in earnings right into your plan. Then you are allowed to contribute an additional 25 percent of your salary, up to a maximum total contribution limit of $53,000. Because of the initial salary deferral feature, you might be able to get to the maximum $53,000 ($59,000 for those over 50) more quickly. For instance, with a SEP-IRA, you would actually need a salary of $212,000 to take full advantage of the $53,000 maximum contribution. With the solo 401(k), by contributing $18,000 upfront and then 25 percent of your salary, you could reach the limit at a much lower income level.

An added bonus is that you can borrow the lesser of $50,000 or 50 percent of your plan contributions should you need money to expand your business. Interest rates are reasonable; however, the repayment period is rather short — five years — so consider your ability to repay quickly when deciding how much to borrow.

The downside of the solo 401(k) is the administrative hassle. The required paperwork is more cumbersome than for other plans, and there are additional longer-term requirements. For instance, once the plan balance hits $250,000, you must file an annual statement with the government.

While not specifically for independent contractors, these plans are good options as well, particularly for those just starting out who can only make modest contributions initially. For both traditional and Roth IRAs, annual contributions are capped at $5,500, or $6,500 if you are over 50. Traditional IRA contributions are made in pretax dollars, while Roth IRA contributions are in after-tax dollars.

The big advantage of the Roth IRA is that your contributions (before any investment returns) can always be withdrawn tax- and penalty free. Earnings are a different story. Withdrawal rules are more complex, and treatment depends on whether you have had the account for more than five years and meet the allowable circumstances for an early withdrawal.

These are just a few of the retirement planning options for independent contractors. These might or might not apply to your circumstances, but can help you get started with your decision.

Weigh your options in light of the contributions you can make now, how much you think you will be able to contribute in the future and whether or not you will remain a solopreneur or will hire employees at some point. Whatever your decision, make it a point to choose a plan and get started with your retirement savings.