ASK KIM
Save Now, Pay Taxes Later
by Kimberly Lankford

Your recent column suggested that it would be better to put money in a taxable account instead of an IRA. So should I not fund my SEP to the maximum but put the money in a taxable tax-efficient account instead? Our combined adjusted gross income is under $150,000 this year, but could rise above that level easily. My thought was that tax savings and deferral of any gains was better than a taxable investment.

You're right. With a SEP (Simplified Employee Pension), like a deductible IRA, 401(k) or other self-employed retirement plan, you get a current income tax deduction, which makes it worthwhile to continue with those investments.

My earlier column talked about investing money in a taxable account rather than a nondeductible IRA. In that case, earnings would ultimately be taxed at your capital-gains rate (up to 15%) rather than your regular income-tax rate (up to 35%) when you withdraw the money. Neither of those investments are tax-deductible when you make your contributions.

But the SEP gives you a tax break now, which can be very valuable. Investing $10,000 in a SEP, for example, will lower your tax bill by $2,500 if you're in the 25% bracket. You will need to pay income taxes on your earnings when you withdraw the money in retirement, but the current tax break puts you ahead today.

Since you're earning less than $150,000, also consider investing up to $3,000 in a Roth IRA, which won't give you a current income-tax deduction but will let you withdraw your earnings in retirement tax-free as long as you've had the account for at least five years (since you're already over age 59½). The Roth also has no required minimum distributions and can be passed to heirs income-tax-free. For more information about Roths, see Good Reasons to Fund a Roth IRA.

For more information about your options for self-employed retirement accounts, see Do-It-Yourself Retirement Plans.