Pension info every indie should know.

June --

I am from Long Island City (Queens), NY I am an Information Architect/Interaction Designer (web development) I have been independent (1099 sole proprietor) less than one year.

I am wondering if you could advise me on issues surrounding a retirement fund. I am interested in the Freelancers Insurance 401k plan. The limit for contribution is $16,500 but there is a profit sharing option which allows you to contribute as much as $49,000. How do I determine if I am eligible for profit sharing?

Daniel


Dear Daniel.

Here's a simple view of how pensions work for self-employeds:

You have a net income. Depending on your income and how much of that income you don't need for immediate living expenses [sometimes called discretionary income] you contribute money to your pension.

You can choose a pension that allows the contribution to be deducted from your income thereby reducing your current income tax. Years from now, when you withdraw the money from your pension you will pay tax on the amount withdrawn.

Or you can choose a pension that does not allow a deduction from income now. So there is no immediate tax deferral. And that means you will not have to pay tax on the money when you withdraw it years from now. These are ROTH versions of a pension account. For instance, you've probably heard of an IRA. This would be a ROTH IRA.

When you are 59 1/2 years old you may start withdrawing from your pension with no penalty. If you withdraw before age 59 1/2 you will have to pay a 10% penalty. There are some exceptions.

There are many different types of pension plans that a self-employed may have. The most flexible and the one that allows the largest contribution is a UNI-K, also know as a SOLO-K or one-person 401-k.

In 2009, if your income is high enough, you may contribute $16,500 plus 20% of your net income. This is not a requirement, this is a maximum. As long as you have a net income you may set up a UNI-K. There are additional contributions allowed if you are 50 years old or older.

To qualify for 2009, the plan must be set up before December 31, 2009. However, you have until you file your 2009 tax return to make the contribution. That could be as late as October 15, 2010.

You set up the plan at a brokerage house, for instance Raymond James or Schwab. Should cost about $ 75 or $100 per year. Be sure to use a brokerage house that allows complete flexibility in investment products. Some houses limit the investments for UNI-Ks.

There are other plans that allow for much greater contribution amounts and cost much more to set up and maintain. They are called Defined Benefit plans. I suggest them to clients who are at least 45 years old and who make a lot of money.

Here are a few other posts I've done on pensions.

Best,
June

Watch out for bad tax advice!

June --

My gentleman is an architect who went independent in 2007.

He has had a few small projects, plus one client who paid him for the 2 weeks-worth of work, but deducted the taxes like they would for an employee. Now he wants to have his taxes done, and has income from both indie jobs and the one tax deduct situation.

Can he still file as an indie?

He went to an AARP tax advisor who told him that he could not claim expenses over $5,000. max. I do not remember reading anything in your book about maximums - did I miss something?

He has a dedicated room in his house as a home office - there is nothing personal in it at all. He was told that he cannot make any of the % deductions without a certificate from his city (Altamonte Springs FL) showing that the sq ft of the office is his business...?

Thank you for helping us -

Susan
Orlando, FL


Dear Susan,

You have received a lot of wrong info. Get away from your AARP tax advisor, but please don't just walk away, write to AARP, perhaps with a copy of this email, to inform them that they have people with inadequate knowledge advising indies.


Now to your questions:

-- In order for the architect to be paid as an employee he would have to have filled out a W4 rather than a W9 for the client. If he did, then it's his error. Something got lost in translation.

-- Yes, someone can be an employee and an indie. That is often the case with self-employed people who have a "day job."

-- I have no idea where AARP got the $5,000 amount. No such thing!!!!

-- Regarding home office: Local zoning laws such as permits to work out of your home, have no bearing on deducting home office on your tax return. [There is an exception on this for daycare.]

Please let me know what happens with AARP.

-- June

Another Misinformed Tax Pro about Husband & Wife Business

June --

My husband has been self employed architect since 1991.

Since its inception, we have had a small business health insurance plan NOT INDIV with me as one employee.

Each year I issue a small paycheck to myself for my bookkeeping services and pay payroll taxes on it. The cost of the premiums has always been deducted as a business expense a NOT PERSONAL DEDUCTION.

For reasons unknown to me, our accountant of 3-4 years abruptly declined to list our health insurance as a business expense this year although nothing has changed. He just said that unless my W2 equals the annual premium, then forget it. I do not wish to change the way I file my health insurance after 15 years? What gives?

Rosemary & Michael
Culpeper, VA


Rosemary --

"What gives" is that your accountant was doing it wrong for 3 or 4 years and didn't want to tell you.

Often health insurance plans will call a spousal assistant an employee. However, just because you have a group health insurance policy that treats you as an employee does not make you an employee.

You cannot deduct health insurance premiums from business income unless that health insurance is provided by the business for a legitimate employee.

Here's how it works:
Husband [or wife, doesn't matter] has a sole proprietorship. Wife is made an employee via the registration and filing of all federal and state employment forms. Wife is paid by check or direct deposit from the husband's business.

Husband sets up health plan benefits for his employee. It's called a Plan 105. This must be formally done. You can get more info on Section 105 from BizPLan at http://www.tasconline.com/products/bizplan/ or I can give you the person to contact. [I have no quid pro quo on this arrangement.] There is also a lot of information on my blog in the category payroll -- spouse as employee .

Once the plan is set up all medical insurance as well as medical expenses for the entire family may be a business deduction.

If your accountant hasn't told you all this -- in greater detail than I can do here -- or does not say he will research and get back to you -- then fire him and get a new accountant!

1/2/11: A new regulation is in effect regarding the deductibility of health insurance premiums by all self-employed. This deduction is not for spousal employees only. So be sure to talk with your tax pro about this.

Best,
June

JW Revised 1/2/11

Decision making on a lot of indie money topics

June,

I've been SE for 4 years as Architect/Environmental Design.

Notified a client of rate increase to $75/hour (undercharged at $50/hr for 4 years--my own fault for not knowing the minimum market rate in So Cal).

Employer came back with $120k/year direct hire employee offer.

Have not yet done '06 taxes (filed extension), still paying '05, none paid so far on '07.

Expenses too high in So Cal. Family of 5, keep house $28k mortgage interest deductions, or take cheap rental home (no mortgage deductions). Mid life and NO retirement.

Should I stay SE to start taking advantage of the SEP IRA opportunities, or go with $120k/year employment offer?

Thanks so much---REMARKABLE WEBSITE YOU HAVE HERE! Leslie from Mission Viejo, CA


Hello Leslie,

My goodness, you have a lot happening and it sounds like you have very little guidance. My first advice: Make no decisions until you get a lot more information. I will do my best to run down the line and deal with each element of your email but do keep in mind that this is an email answer to what appear to be life decisions!!

Many indies don't charge enough money. Every independent professional should call around -- or have a friend make the calls -- and ask the going rate for the kind of services you perform. Whether house painting or business card design or dog walking -- get a price. If you need to raise your fees do it incrementally and don't spring it on a client. For instance, in July send a carefully written notice to clients thanking them for their business and tell them that on September 1st your fees will go up XX% or to $XX.

You say your "employer" came back with an offer. If you're an indie the person to whom you provide services or sell products is not your employer. Only employees have employers.

$120,000 per year divided by 52 weeks divided by 40 hours per week = $57.69 per hour. What benefits are being offered? Keep in mind that business expenses are not as tax advantageous to an employee as they are to a self-employed so that makes that offer less than you are earning at $50 per hour.

Owing money to the government is not terrible. It doesn't mean jail it just means a lot of penalty and interest but at a cost of a lot less than credit card interest.

Rent vs own in your situation is not a snap decision. Your entire financial picture must be looked at and analyzed.

"No retirement" -- well, you don't say how old you are nor at what age you want to retire so that may or may not be a problem. There are many pension plans for indies in addition to the SEP-IRA that you mention. However, you have a lot of other areas to straighten out before you decide on a pension.

I am so glad that my website has helped you. Thanks for letting me know. Be sure to look to the left here on my blog at the various categories. There are 23 posts on "Being Self-employed." I think they will help you in your current situation.

Best regards,
June