I earned some extra money this year by doing freelance software development, and I would like to open up a self-employed retirement plan, such as a SEP or a solo 401(k). Do I need to make my contribution by the end of the year, or do I have until April 15?
It depends on the type of plan you open. You have until April 15, 2008, to open a Simplified Employee Pension and make your 2007 contribution to the plan.
If you're interested in a solo 401(k), you need to open up the plan by December 31, 2007, even though you don't need to make your 2007 contribution until April 15, 2008.
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The best choice for you depends on your self-employment income for the year. It's easier to set up a SEP -- most brokers and mutual fund companies offer them, generally with the same range of investment choices as their IRAs. But you may be able to contribute more money by opening a solo 401(k). Your contributions are tax-deductible with both plans.
Contributions to a SEP are limited to 20% of your business income (which is business income minus half of your self-employment tax), up to a maximum of $45,000 for 2007. So if you earned $15,500 from self-employed freelancing, for example, you could contribute about $2,863.
The maximum contribution for a solo 401(k) also is $45,000 in 2007. However, you can contribute up to $15,500 plus 20% of your business income (defined the same way). Because the first $15,500 in a solo 401(k) is not based on a percentage of your income, you'll generally be able to contribute a lot more to a solo 401(k) than you can to a SEP, especially if you earn just a little extra money from a freelance job.
You can't contribute more than your business income for the year, but if you earn just $15,500 from self-employed freelancing, then you can contribute the whole amount to a solo 401(k).
If you have a regular 401(k) through an employer and have some freelance earnings on the side, then your solo 401(k) limits will be reduced by any contributions you've made to a regular 401(k). But that only affects the first $15,500 of contributions, not the 20% of business income.
For a list of companies offering solo 401(k)s, see the 401(k)helpcenter. Also see Do-It-Yourself Retirement Plans for details about other self-employed retirement plan choices.
And don't forget to write off your business expenses on Schedule C when you file your taxes by April 15, 2008. For details, see Tax Filing for Freelancers: An Introduction to Schedule C.
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