The nature of the job market has shifted coming out of the last recession. As unemployment stayed persistently high for a few years after the recovery, many chose to “go it alone” when employers weren’t hiring. As a result, those opting for self-employment and freelance work rose in numbers. Indeed today nearly a quarter of workers work for themselves, either full-time or part-time. They can make good money at it too, with almost half earning six figures.
There are plenty of perks to self-employment: you set your own hours, you choose who you work with, and you can spend all day in your pajamas and still bill hours if your business is set up that way. However, being self-employed also means you are responsible for providing yourself with your own benefits (i.e. healthcare, retirement plans, life insurance, etc.).
When it comes to retirement savings, regular employees usually have it easy – their employers have done the heavy work of setting up a workplace retirement plan; all they have to do to jumpstart their saving is open an account and select a contribution level.
For the self-employed, retirement planning can be a little trickier, especially if you don’t know what options are available to help you start saving.
The good news is that saving for retirement is not impossible when you’re working on your own, though it may require more effort. Below is an excerpt from an article recently posted by the Fiscal Times’ Beth Braverman. It does a good job summarizing some key things for the self-employed to know when it comes to retirement planning:
You’ll need to put away even more. We recommend that savers stash away at least 15 percent of their income for retirement, including their own money as well as any employer match. Freelancers have to sock away even more income to make up for not getting an employer match. That’s on top of building an emergency fund with at least six months’ worth of expenses that can help weather a dry spell.
It’s important for freelancers to factor the cost of those savings into their business budget to make sure that their earning enough money to cover what W2 employees usually receive in benefits.
You’ve got several options for retirement savings. There are several ways freelancers can save money for retirement. Here are just three to consider:
1) A traditional or Roth IRA: If you already have one of these accounts and aren’t making a ton of money, you can just continue putting aside retirement income there. With a traditional IRA, any withdrawals will be taxed, but you can deduct your contributions.
With a Roth (you’re eligible if your income is less than $120,000), you pay taxes now on your contributions, but the money grows tax-free. You also can make tax-free withdrawals on the principal, so it can double as an emergency fund for new freelancers, although if this is the case you’ll want to keep the investments fairly conservative.
Annual contribution limits for both accounts are $5,500 for younger savers and $6,500 for those over 65.
2) SEP IRA: The most common plan for freelancers and sole proprietors, SEP IRAs allow contributions up to about 20 percent of your compensation, or $53,000, that grow tax-free. There’s a complex formula to determine your contribution based on your compensation as a self-employed person. Use this calculator to find the exact amount.
A nice benefit of SEP IRAs is that the deadline for contributions is either Tax Day or when you file your taxes. So, you could put away just 5 percent of your income all year, but decide in February to put another 20 percent in because you find that you have the extra income. That can help you make up for any leaner years when you couldn’t contribute as much. (The same benefit applies to IRAs and Roths, but at much lower limits.)
You can set up a SEP IRA with almost any bank or brokerage, and fees tend to be minimal. It’s a very cost-effective option.
3) Solo 401(k): Also known as an individual 401(k), these accounts let you put away $18,000 as an employee. Additionally you can contribute about 20 percent of your compensation (again, use the above calculator to determine the exact amount) or $53,000, whichever is less, as your own boss. Those over age 50 can put in an extra $6,000, and spouses who work together can both put in $53,000.
A Solo 401(k) may cost more to set up and require additional paperwork at tax time, but its assets are protected from creditors under the Employee Retirement Income Security Act. Contributions must be made before the end of the calendar year.
Many Solo 401(k)s also offer the option to borrow against your retirement savings, although experts say that doing so is rarely the best financial move.
Skip automation. Most retirement accounts offer an auto-fund option allowing you to set aside a predetermined amount of money each month. That can be more difficult for freelancers, since your income fluctuates. Instead, consider making contributions a few times a year, for example around the same time that you pay your estimated quarterly taxes.
Plan to work longer. Since freelancers control their schedules and how much work they take on, they’re ideally situated to ease into retirement. If you plan to continue working (even if you’ve scaled back) to delay drawing down your retirement funds, then you can retire more securely on a relatively smaller nest egg.