More and more working Americans are aware of the power of 401(k) plans and IRAs when it comes to retirement planning — and more and more of them are aggressively using these plans to invest in their futures. But what do you do if you're one of the 25 million Americans who are self-employed and you want to contribute more than the $5K (or $6K if you're over age 50) that you can put into an IRA? Perhaps you work on a freelance basis or own a small business. How will you prepare for what I've often referred to as the biggest financial challenge of all: creating wealth for a comfortable, financially secure retirement?

You may not have a convenient employer-sponsored plan at your disposal, but you still have plenty of options. In fact, depending on your income and the plan you select, you might be able to stash away quite a bit more money than a similarly compensated worker enrolled in a 401(k) plan. Your choices vary in the amount of money you can contribute, have different levels of administrative responsibilities and fees, and have different features that might make one plan a better fit. Of course, once your plan is set up, you'll need the discipline to take advantage of it.

 
IF YOU’RE ON YOUR OWN

Let's first take a look at the case of a sole proprietor, typically someone who works on a freelance basis and has no employees. In 2008, both a SEP-IRA (SEP is for ’??simplified employee pension’??) and a QRP (’??qualified retirement plan,’?? also known as a Keogh plan) will let you make an annual tax-deductible contribution of up to $46,000 or 20 percent of your net self-employment income, whichever is lower.

This is a huge opportunity to reduce your taxable income and invest in your future. By way of comparison, employees who participate in a company-sponsored 401(k) plan are limited to annual salary deferrals of $15,500 for 2008 (plus another $5,000 for those 50 and older taking advantage of the ’??catch-up’?? provision). (Although the employer may well contribute more, up to a combined ceiling of $46,000 in 2008.)

If you're trying to choose between these two plans, the SEP-IRA has the advantage of much easier set-up and fewer ongoing administrative responsibilities. Any broker-dealer can help you set one of these plans up, and you are free to invest your contributions in any listed security or fund.

You'd need a pretty big income to get to the $46,000 level with a SEP-IRA or a QRP: $230,000. If you earn less but want to contribute a higher percentage, consider an ’??Individual 401(k) plan.’?? Like the other SEP-IRA and QRP, you can contribute up to 20 percent of net self-employment income, plus you can make an elective deferral of an additional $15,500 up to the $46,000 ceiling.

If you're 50 or older, you can take advantage of the catch-up provision and defer another $5,000 in income. In other words, under certain circumstances, with an Individual 401(k), you can make a tax-deferred contribution of as much as $51,000 in a single year. (Note: The catch-up provision is not available for SEP-IRAs or QRPs.)

There's still an additional option for the self-employed, and this one is potentially valuable for older people who are nearing retirement and want to save the maximum amount of money in just a few years. If you fall into that category and have relatively high income, you can create your own defined-benefit pension plan (as opposed to the defined contribution plans described above). The amount you can contribute depends on actuarial factors as well as your earnings, making it possible to contribute even more than is allowed in a SEP-IRA or Individual 401(k). You'll need more guidance with this one, but most firms with retirement expertise can assist you.

IF YOU HAVE EMPLOYEES

If your small business has employees, you can establish a SEP-IRA or a QRP and enroll your workers along with yourself — but you'll have to make the contributions to their accounts. There's a less expensive option if you want them to do most of the saving themselves: a savings incentive match plan for employees, otherwise known as a SIMPLE IRA. On the plus side, a SIMPLE IRA is easy to set up and manage, and it enables you and your employees to contribute any fraction of income up to a ceiling of $10,500 (which can make the SIMPLE IRA a good choice for someone with a relatively low income who wants to contribute a large percentage to his or her retirement plan).

As the employer, you must make a small matching contribution — between 1 percent and 3 percent — of each employee's compensation. Even though you're the owner, for the purposes of the SIMPLE IRA you're also considered an employee, so you can defer up to $10,500 plus the match. This plan also allows workers over the age of 50, again including yourself, to make an additional ’??catch-up’?? contribution of up to $2,500. Note that even if you're the sole employee, you can still adopt a SIMPLE IRA, but one of the other plans might enable you to defer even more money from current taxes.

THE BOTTOM LINE

How do you choose? The decision comes down to a few variables: Do you have employees and need to create a tax-deferred retirement plan for them as well as yourself? How much money do you make? How old are you? And finally, how difficult (and expensive) is the plan to administer?

If you have employees, you should probably consult with a retirement plan specialist to determine the best choice. If your business is just you (and perhaps a spouse or other family member), pick the plan that offers you the biggest possible deferral based on your income and your age. As I've said many times, retirement is an expensive proposition, and you should take advantage of every tax break you can to help you meet your goal.

Carrie Schwab Pomerantz is Chief Strategist, Consumer Education, Charles Schwab & Co. Inc., Member SIPC. You can e-mail Carrie at [email protected]. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.