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Q.As a sole proprietor, should I set up a SEP-IRA, SIMPLE IRA, or Solo 401(k)?

A.All retirements plans, excluding the Roth IRA and the Roth 401(k) provide a tax deduction for each contribution, and in all of the plans your investments grow tax-deferred until you begin making withdrawals.

A SEP IRA (Simplified Employee Pension) is a simple retirement plan that functions like a traditional IRA, but allows the self-employed individual to contribute (for 2008) the lesser of: (1) 20% of his or her self-employment income (25% of salary) or (2) $46,000. With a SEP-IRA the annual contributions can vary and the amount of the contributions is deductible as a business expense for the employer

The SIMPLE IRA also functions like a traditional IRA, but it allows the self employed individual with up to 100 employees to contribute up to 100% of their self-employment earnings with a maximum contribution of $10,500, ($13,000 if you are age 50+).

If your net self-employment earnings is less than $42,000, a SIMPLE IRA will allow a higher contribution than a SEP IRA.

If you have employees, the SIMPLE IRA requires an employer contribution. The employer contribution can be either: (1) a dollar-for-dollar matching contribution of up to 3% of the employee's compensation or (2) a non-elective contribution of 2% of the employee's compensation. If the employer chooses to make the non-elective contributions, it must make them for all eligible employees whether they individually contribute or not. The maximum aggregate contribution limit for 2008 is $21,000 ($23,500 if age 50+).

A Solo 401(k) Plan can be established by any “single owner” business with no employees, including a sole proprietorship, partnership (husband and wife), limited liability company, or corporation. A Solo 401(k) plan allows the self-employed individual to make a contribution both in the role of employee and in the role of employer. The contribution limit (for 2008) is up to $46,000 ($51,000 if age 50+). The contribution is made in two parts: (1) a direct contribution by the employee of up to $15,500 for 2008 ($20,500 if age 50+), and (2) an additional contribution by the employer of up to 25% of the employee’s compensation income, or up to 20% of your self-employment income.



IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this web site is not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed on a taxpayer under the U.S. Internal Revenue Service.




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