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Setting Up A SEP-IRA

You can set aside retirement money even though you're the boss.

Cooking for an easy way to cut your business taxes? Open a tax-deferred retirement account created just for small-business owners. One plan, the Self-Employed Pension-Independent Retirement Account, also known as the SEP-IRA, is designed to be easy to open and maintain, while taking advantage of tax-free investing.

The SEP-IRA account is available to anyone earning income from self-employment. You can open a SEP-IRA whether you are running your business part time or full time, and whether your company is structured as an S corporation, a partnership or a sole proprietorship. Of the three major plans--the Keogh, SEP-IRA and, for the 1997 tax year, the Savings Incentive Match Plan for Employers (SIMPLE), only the SEP-IRA permits contributions even if you're covered by another plan, such as a 401(k), at another job. A SEP-IRA is as easy to open as a standard IRA account and offers the most flexible funding options.

Its flexibility is what sets the SEP-IRA apart from other retirement plans. Annual contributions can be as little as zero and as high as 15 percent of your net profit, for a maximum of $24,000--much higher than the $2,000 maximum for an individual IRA. In the years when your business is booming, you can contribute the maximum, and in leaner years, you can contribute less. And you can even wait as late as April 15 to open an account and make a contribution for the previous tax year.

One big advantage of opening a SEP-IRA is the possible tax benefit. Contributions are tax-deductible for the year in which they are made. As with other retirement plans, your contributions--plus the earnings, dividends and interest on your investments--grow, tax-free, until you withdraw the funds after age 59 1|2. If you take the funds out before that time, however, the withdrawn amount is fully taxable and may be subject to a 10-percent penalty.

Small-business owners often start with a SEP-IRA plan, switching to another type of plan later, as their businesses grow.

Joanne Sammer, a marketing-communications consultant in Point Pleasant, New Jersey, opened her SEP-IRA account in 1995 while still operating her business part time. "Because I had no idea what my income would be in the first couple of years, I needed something to which I could contribute as much or as little as I wanted," says Sammer. "I had thought about opening a Keogh, but the paperwork is more involved, and I just didn't want to be bothered."

Betsy and John Caruso did just the opposite. When they started their mailing-services company, Signed Sealed Delivered Inc., in Norristown, Pennsylvania, their financial planner recommended they invest in a Keogh plan so they could take advantage of the higher contribution limits. But when they incorporated Carusos switched to a SEP-IRA, because Keogh plans are not available to corporations.

Betsy prefers to leave the management of their SEP-IRA to an expert: "We rely on the advice of our financial planner, and review our needs at least annually," she says.

Even when your business grows larger, you can continue to invest in a SEP-IRA plan. John Seiffer, a business coach and owner of two companies in Bethel, Connecticut, has had a SEP-IRA for three years while his businesses have grown in gross revenues to more than half a million dollars. "It's important not to have all your money tied up in your business," Seiffer says. "Diversification can actually help you make better business decisions."

A major factor when considering a SEP-IRA is the impact of extending benefits to employees. SEP-IRA rules require that a business fund a retirement account for any employee that has worked for the company for three of the last five years and has earned more than $400 in the previous year. The percentage you must contribute for a qualifying employee is the same percentage you contribute for yourself. If, for example, you're contributing 15 percent of your net income to your own account, you'll also have to invest 15 percent of each employee's income in the plan.

Steve Sanders, a registered investment advisor who offers advice on CNBC's "The Money Club," suggests that you consider the number of people your business employs, an estimate of employees' contributions to a plan, and your matching contribution as the employer when determining whether or not a SEP-IRA is right for your business. "Setting up a SEP-IRA or a SIMPLE IRA affords employees an opportunity to save for retirement and can foster goodwill between the owner and employees," Sanders says.

A big mistake some small-business owners make is thinking they can't afford to fund a retirement plan in lieu of putting profits back into the business. Don't ignore the value of investing early. If, starting at age 35, you invested $3,000 each year with a 14 percent annual return, you would have an annual retirement income of nearly $60,000 at age 65. But $5,000 invested at the same rate of return beginning at age 45 only results in $30,700 in annual retirement income. The value of tax-free investing over time means it's best to start right away, even if you start with small increments.

Where can you go to open a SEP-IRA account? Banks, investment companies, full-service or discount brokers and independent financial advisors all offer SEP-IRA plans. Many of these institutions also offer self-managed brokerage accounts where you can combine investments in mutual funds, stocks, bonds and certificates of deposit (CDs).

Note that some firms charge an annual fee for maintaining a SEP-IRA, which can often be waived by setting up automatic deposits or maintaining minimum balances.

You also have as many investment choices for your SEP-IRA as you would have for an IRA account: CDs, money-market accounts, mutual funds, individual stocks and bonds or a combination of any or all of the above.

As with other investments, you should determine your risk tolerance and your financial goals. Reading more about personal finance can help you determine your retirement needs. Most financial planners can tell, just by talking to you, what your risk tolerance and your financial goals are.

For new retirement accounts, though, Sanders recommends mutual funds. "Mutual funds provide options ranging from conservative to aggressive and, most importantly, provide diversity of investment," Sanders says. With mutual funds, you have a choice of investing in everything from stocks and bonds to foreign investments. Most mutual funds require a minimum of just $500 to open.

Whether you open a SEP-IRA account or another retirement vehicle for your business, it pays--this year in tax savings and later in retirement--to start right away.

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