Financial savvy for the self-employed: planning ahead for your retirement can reap high rewards.

THREE YEARS INTO THE BUSINESS AND YOU STILL FIND THAT separating personal and business finances is a weary battle. No matter what you do, you just can't seem to manage the highs and lows that go with generating your paycheck. Well, you're not alone. Many entrepreneurs fail to understand the how and why of doing a personal financial plan and separate business financial plan.

It doesn't matter whether it's a one-person shop or a 50-person operation, the self-employed are bound to have special concerns about managing their money. Don't fall into the trap of spending all your time planning for your business and forgetting to invest and save a part of your income for those nonworking years--retirement. To help you deal with the mechanics of developing retirement and investing strategies, the following advice is from Grace W. Weinstein, personal finance guru and columnist for Investor's Business Daily.

PENSION PLANS FOR THE SELF-EMPLOYED

With no company pension plan, you're on your own when it comes to saving for retirement. Fortunately, Uncle Sam offers some tax-saving ways to put money aside. Try to take advantage of at least one tax-sheltered savings plan even while you are devoting every minute (and every spare dime) to building your business.

It's tough to put money aside in the early years of a business, but the earlier you start to save toward retirement (or any other goal), the better you'll do in the long run. Let's say you manage to save just $1,000 a year for each of the 10 years between your 31st birthday and your 40th birthday; then you stop and don't save another dime. With compounding at 7%, your original $10,000 will become $57,208 by the time you turn 60. By contrast, if you don't start putting money away until your 41st birthday, then invest $1,000 a year each year until you turn 60, you will have put in $20,000, and at the end you will have $43,865. Surely, even now, you can manage to put $1,000 a year into a tax qualified plan for retirement. Here are your choices:

KEOGH PLANS 

Specifically designed for the self-employed, Keogh plans (named after Eugene Keogh, the congressman who came up with the idea) let you put away a good bit of money toward retirement. The contribution itself is deductible and earnings grow tax-deferred; not tax is due on interest or dividends until the money is withdrawn. The idea was that you would then be retired and in a lower tax bracket. This may no longer be the case, with tax rates rising once again, but the tax-deferred compounding can still make a lot of sense.

Defined contribution Keogh plans are the most popular and make the most sense for most people. Here, as with the defined contribution pension plan described above, you put in a specified percentage of your income. The amount of money you'll have at the end depends on how much you've put in and how your investments have performed. Defined contribution Keoghs come in three flavors:

* Money purchase plans are the most restrictive. You decide at the outset what percentage of your income you will put away, up to the stated limit of 25% (actually a bit less because of the way the formula is calculated) and a maximum of $30,000, and then must put that percentage of income away every single year, in good years and bad. Many self-employed people find this a scary prospect.

* Profit-sharing plans let you put away up to 15%, up to a total deductible contribution of $22,500. (The $30,000 cap no longer applies here, as a practical matter, because new rules in the 1993 tax act limit the total annual compensation on which deductible retirement contributions can be based to $150,000; 15% of $150,000 is $22,500.) More important, you can reduce or skip payments if business isn't good.

* Paired or combination plans offer the best of both worlds. You designate a fixed amount for the money purchase portion and then can add more to the profit-sharing portion in years when profits are rolling in, to a combined total of 25%. You might choose to put away a basic 10% of income every year (remember, it's deductible, so the actual cost is less), then add up to 15% more in years when business is booming.

SIMPLIFIED EMPLOYEE PENSIONS

Keogh plans have been the vehicle of choice for the self-employed for a couple of decades now, but an upstart is moving in on the Keogh turf. The Simplified Employee Pension (SEP), sometimes called the SEP-IRA, is similar to a Keogh (the profit-sharing variety) but simpler to set up and administer--more, in fact, like an IRA. With a Keogh you must file annual returns with the IRS; with a SEP you can skip this task. With a Keogh, as noted, you must open the account by December 31, although you can fund it until your tax-filing deadline; with a SEP you have until that tax-filing deadline to both open and fund the account.

The SEP has the advantage of being completely flexible. You may vary the amount you contribute each year, up to a maximum of 15% of earned income (remember, that's really about 13%) and a cap of $22,500 a year; you may even skip a year entirely if you like.

But the SEP does have drawbacks if you have employees, because you must make contributions for every eligible employee--and "eligible" is defined as anyone over age 21 who has worked for you in three of the five preceding years. "Worked for you" means performing any service, with no time constraints.

INDIVIDUAL RETIREMENT ACCOUNTS

You remember the IRA ... the $2,000 a year you could put away, tax-free, while the account grew, tax-deferred, until retirement. That $2,000 a year, of course, is now fully deductible only if you (and your spouse, if you have one) are not otherwise covered by a pension or if you earn below $25,000 as a single person or $40,000 as a married couple filing jointly. Contributions are partially deductible at earnings of up to $35,000 for a single person and $50,000 for a married couple.

If your business is earning below these levels, as it well may be at the outset, an IRA may be the simplest way to stash some money away toward retirement. At higher levels of income (of if you also have a Keogh or your spouse is covered by a pension), you have to decide whether a nondeductible IRA is worthwhile. With these accounts (which should be kept separate from any deductible IRAs you may have), you can't deduct the contribution, but the growth continues to be deferred from taxes until you withdraw the money.

If you make a nondeductible IRA contribution, you must file Form 8606 with your yearly federal income tax return, then hold on to that from virtually forever; you'll need it when you reach retirement age and start making withdrawals from the IRA so that you can calculate the tax due on the withdrawals. The process is complicated because the IRS insists that you cannot withdraw first from one IRA and then from another; instead deductible and nondeductible IRAs must be treated as an aggregate, with taxes figured on proportionate amounts.

The rules for IRAs are similar to those for other tax qualified retirement plans: You may take withdrawals, without penalty, after age 59 1/2; you must start withdrawals after age 70 1/2. Annual administrative fees are tax deductible if you pay them by separate check (assuming, of course, that you itemize deductions). And you have a choice of investment vehicles.

These are your basic Keogh, SEP and IRA investment choices:

* Certificates of deposit at a bank, thrift or credit union. When interest rates are high, you can lock in your return by using a CD of five or more years. When interest rates are low, consider "laddering" maturities, buying a new CD of a fixed length with each year's retirement contribution so that you can take advantage of changing interest rates.

* Mutual funds offer more flexibility, since, once you open a prototype Keogh, SEP or IRA plan with a mutual fund family, you can invest in just about anything--stocks, bonds, treasury issues and so on. When you have many years to retirement, a growth fund can help your retirement money keep pace with rising costs. As you get closer to retirement, you can shift a portion of your plan money to income funds to preserve principal. Yearly fees are usually low, in the neighborhood of $20 or $30; some fund families charge no fees at all. And if you choose a "no-load" fund, one without an upfront commission to a salesperson, all of your money goes right to work for you.

* Self-directed accounts (if you can take the time from your business to manage an investment portfolio) let you buy and sell individual investments within your retirement plan wrapper. You can invest in stocks or bonds, in real estate or in oil wells. But you will pay start-up fees and annual maintenance fees for a self-directed account at a brokerage firm, plus brokerage commissions on every transaction. If you do choose to go this route, compare both cost and service carefully before you select a firm; discount brokerage firms charge less than do full-service firms, as a rule, but they do not give advice. And bear in mind that capital gains within a retirement plan are taxed as ordinary income when the money is withdrawn, while capital losses cannot be deducted against other gains.

* Annuities are sometimes recommended as funding vehicles for Keogh, SEP and IRA plans. But annuities are tax-deferred on their own and, as noted earlier, there's little point in wrapping a tax-deferred retirement account around a tax-deferred investment. Annuities can provide supplemental retirement income but should be separate from your tax-qualified plans.

As your business grows and income becomes more predictable, you should also plan to invest outside your qualified retirement plans and outside your business itself.

SIZING UP TAX-FREE BENEFITS

Each plan has its advantages and disadvantages, so choose the one that best suits your retirement needs and financial situation.

KEOGH DEFINED CONTRIBUTION PLAN 

* Contribution is deductible and earnings grow tax-deferred

* You must file annual returns

* In a money purchase plan, you can invest up to 25% of your income or $30,000 (whichever is less)

* In a profit-sharing plan, you can invest up to 15% of your income, or a maximum of $22,500

* In a paired or combination plan, you have the best of both worlds. You designate a fixed amount for the money purchase portion, then add to the profit-sharing portion as your business grows, for a combined total of up to 25% of your income

SEP REGULAR PLAN

* Contribution is deductible

* No annual returns

* You may contribute up to 15% of your income, or a maximum of $22,500 a year

* You must make contributions for eligible employees

IRA

* Contributions are partially deductible and earnings grow tax-deferred

* Annual contributions limited to $2,000

Source: Black Enterprise, 1996