Great Pension Plans for the Self Employed

Question: Whew! It's been a struggle, but my business is finally clicking. I've paid the price personally, however, and haven't set aside a dime for retirement. I know things change, so what are the best choices and resources for self-employed business owners looking to set up a pension plan now?

Answer: Access to a variety of tax-advantaged retirement plan choices is one of the key perks of self-employment. There are several good options that are easy to set up and cheap to maintain, including the Simple IRA, Simplified Employee Pension IRA (SEP-IRA) and Solo 401(k).

These three plans all offer tax-deductible contributions and money inside the plans grows tax-free until you take it out. But there are key differences - most significantly, how much money you can put in and what happens if you add staff. According to the American Institute of Certified Public Accountants (AICPA), you can't fully fund more than one in a single year, so you need to make a choice.

The Solo 401(k) is best if your business is raking it in and you need to catch up on retirement savings. A generous contribution formula lets you sock away a larger portion of earnings at a lower income level than with other plans. It's also possible to take out a loan against a Solo 401(k). That's a handy feature if you fear locking up your money for years to come.

In 2006, the contribution limit is 100 percent of the first $15,000 of income, plus 25 percent of net income up to $44,000 ($49,000 if you are 50 or older). Two drawbacks: Once your balance exceeds $100,000 you must file IRS paperwork annually, and if you add employees you'll have to switch to a more cumbersome employer version of the 401(k).

The SEP-IRA is great if you run a one-person show and intend to keep it that way. You can open one at virtually any bank, mutual fund company or brokerage firm. The contribution limit is 25 percent of net income up to $44,000 (adjusted periodically for inflation). If you hire help later, however, funding rules can make this plan costly, and loans are not allowed.

One appealing SEP-IRA feature is funding flexibility. These plans let you wait until you file your taxes to fund the plan. So if your income turns out to be higher or lower than expected, you can adjust your contribution to fit.

The Simple IRA is good for entrepreneurs who aspire to run a bigger business. Even if you add employees, you can keep the same plan. But remember that "Simple" stands for "savings incentive match plan for employees," so you will have to match employee contributions up to three percent of pay.

One drawback of the Simple IRA is a low contribution limit. You can stash away no more than $10,000 per year ($12,500 if you are 50 are older), which might be too little.

As a supplement, consider adding a Roth IRA. While the Roth isn't really a business owner plan, it's a great option if you have more savings available after fully funding a SEP, Solo 401(k) or Simple IRA. You can put the maximum $4,000 into a Roth ($5,000 if 50+) if your adjusted gross income is under $110,000 ($160,000 for married couple). You get no tax deduction for the contribution, but money grows tax-free and withdrawals are tax-free in retirement.

If your business is really booming and you want to set aside even bigger dollars, consider a profit sharing plan. This option is more complex and it's a good idea to talk with a CPA or other retirement plan expert about setting it up.

These resources can help:

• The AICPA is a non-profit organization representing 350,000 CPAs. The group offers information on self-employed pension plans at a free public Web site on financial literacy. Go to www.360financialliteracy.org and click on "Entrepreneurs."
  
  
• SmartMoney.com has a good selection of articles comparing retirement plans for the self-employed and strategies for using them effectively. Click "Small Business" in the left column of the home page.
  
  
• The IRS small business Web site at www.irs.gov/smallbiz has details on all retirement plan choices.