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Freelance Finance Column

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If you’re an employee of a company, saving for retirement is fairly straightforward. For most people it entails participating in their employer’s 401(k) or pension plan and contributing to their Traditional or Roth IRA.Freelancers, on the other hand, are faced with many more options on how to most effectively save for retirement. In this column we briefly explore some of the more popular retirement plans for freelancers.Traditional IRA and Roth IRAIn a Traditional IRA, you receive an up-front tax deduction for your contribution and you pay regular income tax rates when you withdraw the money. In a Roth IRA, you don’t get the upfront deduction, but when you withdraw the money, it’s a tax-free withdrawal.The advantage of both types of IRAs is that they are easy to establish and inexpensive to maintain. The major drawback is that the maximum contribution limit is low at $4,000 per year (or $5,000 per year for those aged 50 and over).Simplified Employee Pension (SEP)The SEP-IRA acts much like the Traditional IRA in that you receive an up-front tax deduction for the contribution and are taxed a regular income rate on withdrawal. In addition, like Traditional IRAs, they are easy to establish and inexpensive to maintain and, unlike other pension plans, there are no annual filing requirements.The major advantage of the SEP over the Traditional IRA is that you can contribute a much higher amount each year—up to 20% of your self-employment earnings, or $44,000 (in 2006), whichever is less.Individual (or Solo) 401(k)Historically, due to their high cost and complexity 401(k) plans have been limited to midsize or larger companies. Fortunately for freelancers, over the past several years, companies have developed what are known as Individual or Solo 401(k) plans.Just like they sound, these new 401(k)s are designed for sole practitioners.The Solo 401(k) allows you to put more away than you would be able to under a SEP-IRA. In a Solo 401(k), you can put 100% of your earnings, up to $15,000, into the 401(k). In addition, you can then add 20% of your self-employment income. The maximum total contribution you can make is $44,000 in 2006.So why is this better than a SEP-IRA? Here’s the math: Let’s assume you have $100,000 in self-employment income. Under a SEP-IRA, you can put away $20,000, a very respectable sum. Under the Solo 401(k), you can put away $15,000 plus an additional $20,000 ($100,000 X 20% = $20,000) for a total of $35,000.The disadvantages of Solo 401(k)s are that they are slightly more expensive to set up than a SEP-IRA, there are annual filing requirements and maintenance fees may be higher.Rob Jupille is president of RTJ Financial Management and can be reached at rtjfinancial.com. This article is intended as an overview of options. Always consult your financial manager and/or CPA to help you determine which plan is best for you.

Written by Rob Jupille

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