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Saving Grace

Money-management strageties

Homebased business owners looking toward retirement have an interesting new investment option this tax year--the Roth IRA. Like traditional IRAs, qualified individuals can put up to $2,000 per year in a Roth account. Unlike the typical IRA, however, the Roth IRA permits tax-free earnings and tax-free withdrawals for persons over age 59 1/2 who have contributed to the IRA for at least five years. In addition, Roth IRAs allow penalty-free withdrawals for such expenses as buying a first home and paying for college, although a five-year aging period may apply.

Combined with the SEP IRA for self-employed persons, the Roth IRA is a significant incentive for saving, according to Judith McMichael, vice president of Fidelity Investments in Boston.

"Self-employed individuals must rely on themselves when it comes to retirement savings, and the SEP IRA has always been especially well-suited for smaller businesses, freelancers and independent contractors," she explains. "While we've always recommended that people consider supplementing an SEP IRA or other small-business retirement plan with a [traditional] IRA, the benefits of the new Roth IRA may change the dynamics of this decision for the 1998 tax year."

SEP IRAs allow annual contributions of up to 15 percent of self-employed earnings, with a $24,000 limit; these are higher allowances than those of traditional IRAs. They are also fully tax-deductible, and assets can compound, free of taxes, until they are withdrawn.

Starting this tax year, the Roth IRA allows tax-free earnings and post-retirement withdrawals on contributions of up to $2,000 per year, provided gross income does not exceed $95,000 for single taxpayers or $150,000 for those filing jointly. With Roth IRAs, there is no minimum required distribution at age 701/2, and you can continue to contribute and accrue tax-free assets as long as you earn any income at all.

McMichael recommends self-employed individuals take advantage of both SEP and Roth IRAs to maximize retirement savings. "In deciding which IRA to contribute to first, you'll need to weigh whether the tax deduction [for an SEP IRA] is more valuable now or if the potential for tax-free Roth earnings will be more valuable later," she says. "Generally, the longer you have until you need your assets, the more likely you are to benefit from the Roth IRA's tax-free compounding and distributions. Also, if you expect your future tax rate to be the same or higher than it is today, you might want to consider contributing your first $2,000 to a Roth, and then supplementing that with contributions to an SEP IRA."

Only funds in an existing IRA can be converted to a Roth IRA, so in order to roll funds in a 401(k) or other eligible plan to a Roth, first have them converted into a roll-over IRA. All contributions must be made by the end of the tax year; there are no extensions.

Contact Fidelity at (800) 544-5373 for a free report on retirement options titled "How the New Roth IRA Complements the SEP IRA." Advice and an interactive IRA evaluation tool are available at Fidelity's Web site (http://www.fidelity.com), or go directly to the source at http://www.irs.ustreas.gov

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