Retirement savings are important part of saving for your retirement. But when you're self-employed, you don't have the option of a traditional 401k. Limits on certain investment retirement accounts (IRAs) can also make it difficult to build up a large nest egg, so you may be considering opening a Simplified Employee Pension, or SEP IRA, which allows you to save more. You can contribute to both a SEP and a Roth IRA if you are self-employed.
The Roth IRA is funded by individuals using after-tax dollars. You simply set up an account in your own name and fund it. The SEP IRA, on the other hand, is primarily funded by an employer. As a self-employed person, you are both employer and employee and can set this up in your name, funding it as an employer. You are also allowed to make contributions to your SEP as an employee, but this is subject to the yearly limits.
SEP Contribution Limits
Employers are allowed to contribute the lesser of 25 percent of an employees salary, or $49,000 as of 2011. As a self-employed person, you can figure your salary either as a wage that you actually pay yourself, or as your profits after paying all expenses. As an individual, you can contribute a maximum of $5,000 to all IRA accounts combined, which you could divide between a SEP and Roth IRA, if you desire.
IRA Contribution Limits
Contributions to all IRAs cannot exceed $5,000 ($6,000 if 50 or older) or your earned income, whichever is less. This can include SEP, traditional or Roth IRAs. For example, you could put $5,000 in a Roth IRA only, or $2,500 in a traditional and $2,500 in a ROTH, as long as the total amount contributed to all of your IRAs does not exceed $5,000 a year.
Advantages of Both
If you can afford to do so, you may want to look at investing in both types of IRAs. The Roth IRA offers tax advantages that allows you will withdraw your money tax-free when you retire, however, the SEP IRA allows you to put away a lot more money in tax-advantaged accounts.
Maggie McCormick is a freelance writer. She lived in Japan for three years teaching preschool to young children and currently lives in Honolulu with her family. She received a B.A. in women's studies from Wellesley College.