Best Health and Retirement Plans for the Self-Employed

Health Benefits

1. Grab the subsidized COBRA deal, if you can

The federal stimulus package made COBRA, which allows you to temporarily continue your ex-employer’s benefits, much more affordable for many people. In the past, you had to shoulder up to 102 percent of the cost of the premiums to extend benefits for up to 18 months. Now, Uncle Sam will cover 65 percent of the cost for up to nine months if you have lost your job between Sept. 1, 2008 and Dec. 31, 2009.

But there are a few catches: In most cases you must enroll within 60 days of becoming unemployed, your annual household income must be under $125,000 (under $250,000 if a joint filer) and you must have worked at a place with 20 or more employees. If you fit those criteria, you can save serious bucks. In Illinois, “a family of four might have had to pay $1,200 a month for COBRA, but now it’s only about $400,” says Mark LaSpisa, a financial planner with Vermillion Financial in South Barrington, Ill. The older you are, the more COBRA can be beneficial, since your risk of being rejected for health insurance grows as you age.

2. Find a group

When you’re going solo, the best way to secure new, affordable health insurance is to get coverage as a part of a group. Obviously, if it’s possible to enroll in your spouse’s health plan, do it. Vito Sclafani, 46, founder and owner of Vasco Accounting in New York City, pays just $150 a month for family health coverage through his wife’s 20-hour-a-week job as a court attorney for New York State . “Otherwise, I’m sure I’d be paying between $600 and $1,200,” says Sclafani. If you were laid off, the federal HIPAA law guarantees your ability to become covered by your spouse’s health plan as long as you sign up within 30 days of losing your benefits.

There are several other ways to get cheaper group rates. Consider joining an association or professional society, since these organizations often sell cut-rate health coverage to members. Check if your Chamber of Commerce offers a health plan for local business owners and sole proprietors. Even your college alumni association may give you access to a group plan. In 30 states, the nonprofit Freelancers Union has health insurance for self-employed people in certain fields, such as financial services and media. Search for more groups at the Artists’ Health Insurance Resource Center’s site. (Select your state on the map, then “Insurance through Associations.”) Despite the group’s name, you don’t need to be an artist to qualify for many of the coverage choices, just self-employed.

3. Shop for a high-deductible plan

If you’re forced to buy an individual (not group) policy, brace for sticker shock. Nearly three out of four people shopping in the individual market give up due to high costs or a pre-existing condition, according to the Commonwealth Fund, a health policy research foundation. The price varies depending on your age, your state and other factors. But, as an example, the average annual cost for individual coverage in New York is $4,458.

One good way to cut costs: Buy a high-deductible health plan, also called a “catastrophic” plan, designed to cover large medical bills. You’ll typically pay up to $1,150 to $5,000 a year for out-of-pocket expenses (vs. a few hundred dollars on a standard policy), but monthly premiums can be as much as two-thirds lower than a traditional policy. In California, “if a husband and wife get a policy with a $2,500 to $5,000 deductible, their monthly premium would be around $500,” says Kim Foss-Erickson of Empyrion Wealth Management in Roseville, Calif.

“These are very cost efficient for people who are transitioning [to self-employment] and need to lower their expenses as they get started,” says Thomas Gore, a financial planner with Core Advisors in Chapin, N.C. If you do go for a high-deductible plan, expect to open your wallet to pay for routine doctor’s visits and some or all of your prescriptions

A high-deductible plan has helped Bill Shireman, 51, CEO and founder of San Francisco environmental consulting firm Future 500, keep his health costs down. He shopped for a Blue Cross policy with the highest deductible he could find ($5,000), setting him back only about $100 a month. That’s roughly $200 a month less than what his wife pays for her insurance. “I want to be covered in case I get hit with a big hospital bill, but otherwise I don’t want to have to pay a lot for health insurance,” Shireman says.

4. Open a Health Savings Account (HSA)

To help lower your out-of-pocket costs with a catastrophic policy, open an HSA, a tax-advantaged goody available to anyone under 65 whose plan has a deductible of at least $1,150 (or $2,300 for a family). Think of an HSA as the health care equivalent of an IRA. You put pre-tax money into the HSA’s interest-bearing account, CD or mutual fund, and then withdraw cash tax-free as needed to pay for medical costs. You can stash up to $3,000 in an HSA in 2009, $5,950 for a family. People 55 or older can contribute an additional $1,000. Just make sure this is money you can earmark for your health; non-medical withdrawals before age 65 get hit with a 10 percent tax penalty, plus ordinary income taxes. “If you have a $2,500 deductible, and you save $2,500 in your HSA, you’d have covered 100 percent of your health care costs for the year,” says Gore. Find health insurers who offer HSA-qualified plans at HSAInsider.com or eHealthInsurance.com. If you’d rather work with an insurance agent, you can find one in your area at the National Association of Health Underwriters Web site.

Many financial planners recommend contributing the maximum each year to your HSA, if you can afford it. You needn’t worry about losing money in case your annual health expenses run less than your contributions, the way you would with an employer’s Flexible Spending Account. With an HSA, whatever’s left at the end of the year rolls over into next year’s account. So unused balances built up over time can supplement your retirement savings, says Gore, since you can withdraw money after 65 for any purpose without owing the 10 percent tax penalty (though you’ll still owe income tax on non-medical costs).

When you start working for yourself, you may be hesitant to tie up money in a retirement plan. After all, you may not know what your income will be. So you may worry about locking up cash you might need for everyday expenses. But look at it another way: if you don’t save for your future, who will? When you’re your own boss, there’s no automatic 401(k) savings coming out of your paycheck, let alone a company match.

Small business owners and freelancers have an alphabet soup of tax- advantaged self-employment retirement plan choices, from SEP to SIMPLE plans. The trick is figuring out which is the best for you. Below are four common scenarios faced by the newly self-employed; follow the advice that most closely matches your situation:

• Scenario 1: You’re just starting a business and want to save up to a few thousand dollars for retirement this year.
• Best Retirement Plan: IRA or Roth IRA

Even if you’re not earning much yet, begin making retirement savings a habit with small, regular investments. “Just start with $25 or $50 a month, then double the amount each year,” says Foss-Erickson. “Make it incremental and routine—just like you get up each day and exercise.” (And even if you don’t exercise, make sure you make those contributions.)

The easiest way to do it is by opening an IRA, investing the money in a mutual fund and setting up automatic monthly transfers from your checking account. In 2009, you can contribute up to $5,000 ($6,000 if you are 50 or older). If you open a traditional IRA, your contribution is tax-deductible, your earnings grow tax-free and you can start withdrawing money without a penalty once you turn 59 and a half, although you will have to pay income tax on the withdrawals.

You may be reluctant to commit a set amount each month if you expect your income to fluctuate. “If you’re in real estate, there may be no money for months, then boom, you get a bunch of checks,” says Foss-Erickson. In that case, make a small, monthly automatic deduction each month and then an additional lump-sum deposit at the end of the year if you can. “You can choose a no-load fund like Vanguard Wellington (VWNEX), which offers a good, diversified mix of stocks and bonds for a small balance,” says Foss-Erickson.

If you expect to be in the same or higher tax bracket in the future and your 2009 income will be under $120,000 (under $176,000 if you’re married and filing jointly), you might want to save instead with a Roth IRA. You won’t get a tax deduction for your contributions, but all withdrawals will be tax-free. In addition, you can pull out your contributions at any time without incurring a tax penalty. Another advantage: If tax rates increase in coming years, as many expect they will, your Roth will be blissfully unaffected. The Roth IRA contribution limits are the same as for traditional IRAs.

• Scenario 2: You’re under 50, making a good income, have no employees and want to shelter more than the IRA’s $5,000 with a minimal amount of paperwork.
• Best Retirement Plan: Simplified Employee Pension IRA (SEP-IRA)

The SEP gives you an upfront deduction and lets you shelter significant sums of money with little hassle. In 2009, you can put in as much as 25 percent of compensation (20 percent of income if you are not incorporated), up to $49,000. This retirement plan is best if you work alone because if you have employees, you must invest for them the same percentage of income as you’re investing for yourself. You can probably set up a single-person plan online in less than 10 minutes.

Future 500 CEO Shireman says a SEP was a logical progression in his retirement planning. For the first several years after going independent, Shireman’s approach to retirement was “haphazard at best.” Says Shireman: “I basically tossed money into an IRA whenever I had anything extra, and I would try to max it out each year.” Over time, he started to earn more, but also went through a divorce, during which “I gave away most of my retirement money.” Shireman then began working with a financial planner to rebuild his retirement savings, opened a SEP at TD Ameritrade and started contributing the max annually. He says he earns an average of $100,000 a year now. Between the SEP and a SIMPLE IRA (more on that below), Shireman has saved about $1 million.


• Scenario 3: You’re making a modest income from sideline self-employment work and want to save and shelter as much as possible.
• Best Retirement Plan: A SIMPLE (Savings Incentive Match Program for Employees) IRA

Unlike a SEP IRA, there’s no restriction on the percentage of compensation you can contribute pretax, although you can’t put away more than $11,500 in 2009 ($14,000 if you’re 50 or older). So if you’re earning no more than that as an entrepreneur, you could conceivably shelter all your self-employment earnings. Say you’re in your 40s and will rake in $50,000 from self-employment this year. You could put away $11,500 in a SIMPLE IRA vs. $10,000 in a SEP.

If you have employees and want to open a SIMPLE IRA, you must make contributions for any of them who earned at least $5,000 for the past two years. You can either match employee contributions with up to 3 percent of salary for those who participate in the plan, or up to 2 percent for all employees.

• Scenario 4: You’re on your own or have a business partner (but no employees), have a fairly high income and want to shelter as much you can in your retirement plan.
• Best Retirement Plan: A solo 401(k) plan

This option is available only to sole proprietors (or their business partners) who have no employees other than a spouse. Think of it as a turbocharged 401(k), because you make regular 401(k) contributions as an employee and top them off with profit-sharing contributions as an employer. As employee, you can invest up to $16,500 of salary; as employer, you can make whatever profit-sharing contribution you want, as long as the total doesn’t exceed $49,000 ($54,500 if you’re 50 or over). “The administrative tasks are more significant than for a SEP IRA, but if you’re looking to shelter every last nickel, the individual 401(k) is wonderful,” says John Heywood, principal with Vanguard’s retail investor group.

Freelancers interested in this type of retirement plan might investigate the new solo 401(k) plan offered by the Freelancers Union in partnership with Charles Schwab and benefits consulting firm Milliman. The plan has no minimum investment, low fees ($40 to set up, then $11 a month), and an automatic monthly payment option.

More on MoneyWatch:

• Best Retirement Plans for Newly Self-Employed
• Retirement Report Card: Are You Saving Enough?
• Health Care Reform: How Will It Affect You?
• Rebuild Your Retirement Savings
• Layoff Insurance Is a Sales Gimmick
• Why You Want a Tax-Free Roth for Retirement