Are You Self-Employed? There’s More Than One Way to Save for Retirement

The good news is that because you’re self-employed, you have lots of options available to you. Let’s take a look.

How a SEP-IRA works
One great option is a Simplified Employee Pension Plan (SEP-IRA), which is specifically designed for self-employed individuals and small business owners who want to save more but keep paperwork to a minimum. Like SIPP pension investments, it’s easy to open and lets you make fairly high annual contributions. It also gives you the flexibility to vary contributions-or skip them entirely-according to your yearly business needs.

You don’t say if you have employees, but if you do, you will need to make equivalent (percentage-wise) contributions on their behalf. So be sure to factor that in.

A big plus of a SEP-IRA is that it allows you to sock away a significant chunk of money; after a fairly convoluted calculation, the maximum works out to be 20 percent of your net income after subtracting self-employment tax-but no more than $49,000 for both 2010 and 2011 (up to the due date of your return, plus extension). While there are online calculators to help you determine your maximum contribution, it’s probably wise to get your exact figure from your accountant.

Once your SEP is up and running, it works like an IRA. Contributions are tax deductible, earnings grow tax-deferred, and you won’t pay income tax on either until you withdraw them. And just like an IRA, you can make withdrawals penalty-free at age 59½.

A couple of other choices
You might also look into an Individual 401(k). Your yearly contribution could potentially be higher and you’re allowed to borrow against your balance within certain limitations.

If you have employees, A SIMPLE IRA (Savings Incentive Match Plan for Employees) allows both employees and employers to contribute to traditional IRAs set up for employees. It’s ideally suited as a start-up retirement plan for small businesses. Your tax advisor can help you weigh the pros and cons of your different choices.

Adding another IRA
Having a small business retirement plan doesn’t prevent you from opening an individual IRA. Depending on what you qualify for and what makes the most sense tax-wise, you could also make a maximum total yearly contribution of $5,000 to either a traditional IRA, a Roth IRA or a combination of the two.

You can contribute to a small business plan and still get a full tax deduction for a traditional IRA contribution as long as your income falls within a certain range. For single filers in 2010 and 2011, adjusted gross income must be $56,000 or less. The tax deduction phases out between $56,000 and $66,000. For married filing jointly, the limit is $89,000 in 2010 ($90,000 in 2011) with the phase out between $89,000 and $109,000 (and between $90,000 and $110,000 in 2011).

As you may know, there’s no upfront tax deduction for contributions to a Roth, but withdrawals at age 59½ are tax-free. However, your eligibility also depends on income. The income limit to make a full Roth contribution in 2010 is $105,000 ($107,000 in 2011) for singles, $167,000 ($169,000 in 2011) for married filing jointly.

If you expect to be in a lower tax bracket later on, a traditional IRA probably makes the most sense. On the other hand, if you expect to be in a higher tax bracket at retirement time-and you qualify-a Roth is a choice worth considering.

Crunching the numbers
Bottom line, while there’s no specific limit on the number of accounts you can have, there is a limit on the amount of tax-advantaged contributions you can make each year. So I’d first talk to your accountant or tax advisor to see what combination of accounts gives you the best savings and tax advantages. Then make a commitment to fund them to the maximum you can afford.

If you can save beyond the limits of your retirement plan and individual IRA, open a taxable brokerage account and ramp up your savings even more. You’ve got a bit of catching up to do, but it sounds like you’re ready to get started. Good luck!