Is deferring taxes worth hassle?

Q: I'm taking early retirement late this year and I plan to start my own business next year.

Here's my question -- does it make any sense to start a Simplified Employee Pension plan or would I be better off just paying taxes and saving money outside a retirement plan? I think I'll clear around $20,000 from my business and only plan to keep the business for five years until I fully retire. It seems that to save taxes now on a small amount of money only to pay later isn't worth the effort and expense of setting up a plan.

We won't need the $20,000 from my business to meet expenses; my wife and I will have Social Security and pensions totaling around $64,000 beginning in December of this year.

A:Congratulations on your semiretirement! You should fully fund your Roth IRAs before you fund anything else. You and your wife can each invest $4,000, plus a $500 catch-up contribution, if you are 50 or older in 2005.

Contributions to a Roth IRA are not tax-deductible, but they are still attractive investment vehicles for someone in your situation.

* There is no age limitation as long as you have income.

* You may continue to contribute after age 70 1/2 if you are still working.

* Participation in a retirement plan does not affect your ability to contribute.

* Qualified distributions are nontaxable, including earnings.

* Distributions are not required until the owner's death.

* Distribution is not required after age 70 1/2.

To make a contribution, your adjusted gross income must be less than $160,000 for joint filers and $109,000 for a single filer. To make the maximum contribution, your adjusted gross income must no more than $150,000 for married filing jointly or $95,000 for singles.

If a married couple meets the adjusted gross income qualification, both spouses may contribute to separate Roth IRAs even if one spouse has no earned income.

At current federal tax rates, a married couple filing jointly will pay 10 percent on taxable income up to $14,600, 15 percent on income of $14,600 to $59,400, and 25 percent on income between $59,400 and $119,950. Excluding account exemptions and deductions, most of your business income will be taxed at 25 percent.

The jump from the 15 percent to 25 percent tax bracket is costly. Unless you think your income will increase after your business ends, I would shield income from taxes now and try to stay in the lower bracket.

Setting up a retirement plan doesn't take much effort, and it need not be costly. Instead of a Simplified Employee Pension plan, consider a Simple IRA.

The SEP would limit the contribution to 15 percent of your business income. The Simple IRA will allow you to contribute 100 percent of compensation up to the contribution limits. Limits for 2005 are $10,000, plus a $2,000 catch-up for those age 50 and older.

The deadline to start a Simple IRA is Oct. 1 of the current tax year, so you have plenty of time to set this up for next year. An employer match is required. This is generally 3 percent of the employee contribution, on a dollar-for-dollar basis.

Establish your Roth IRAs and your Simple IRA plan at a discount brokerage or with no-load mutual funds. The costs will be nominal, and you should be able to find good investments that meet your goals.