Both a regular IRA and a SEP-IRA allow you to put money aside for retirement, but the rules governing those plans are different. You can only contribute to a traditional or a Roth IRA if you have earned income, making these plans perfect for traditional workers. But if you have income from self-employment or a small business, you can contribute to a SEP-IRA and trim your tax bill while you enhance your retirement savings.
The Simplified Employee Pension, or SEP-IRA, is designed to help self-employed individuals and small business owners prepare for retirement. If you have income from self-employment like work as an independent contractor or consultant, you can shelter a portion of that money from taxes by contributing to a SEP-IRA. The total allowable contribution for 2011 is $49,000, but the amount you can contribute is determined by your earnings. You can use a SEP-IRA calculator to determine how much you can save.
You must have earned income, such as wages, before you can contribute to a traditional or Roth IRA. The amount of that earned income must be as much or greater than the amount you contribute. For instance, the 2011 limit for IRA contributions is $5,000, plus an extra $1,000 if you are 50 years of age or older. That means a 55-year-old worker would have to have wage income of at least $6,000 before he could make the full 2011 IRA contribution.
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Traditional vs. Roth
If you have earned income, you can contribute to either a traditional or Roth IRA. With a traditional IRA, you get a tax deduction based on the amount of your contribution. The downside is that you must pay taxes at your ordinary income tax rate when you take the money out in retirement. A Roth IRA turns this formula on its head, allowing you to take the money out tax-free in retirement in exchange for giving up the immediate tax deduction.
If you have wages from a traditional job plus additional income from self-employment or a small business, you may be able to contribute to both a traditional or Roth IRA and a SEP-IRA. Contributing to both plans can lower your tax bill substantially, while giving your retirement savings a boost. You can check with your CPA or tax preparer to see if you are eligible for both plans. Both traditional and Roth IRA accounts are subject to income guidelines, so it is important to make sure you meet the criteria before making an annual contribution.
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