Millions of American’s are either a freelancer or are self-employed. Although this comes with the benefits of flexible hours and working where you want, it doesn’t come without challenges. One of the biggest being able to save for retirement!
It’s not that freelancers don’t have the money. Because in fact, freelancers might be able to put aside more than employees of companies. With tax-friendly retirement options available, self-employed workers may save as much as 25% or $55,000 of eligible compensation (whichever is lower) in the tax-deductible SEP IRA plans.
So, what’s the problem then?
For one, freelancers don’t benefit from the employee match most corporations offer on 401(k) plans, which can make a huge difference in the amount people have in their account come retirement.
And for the freelancers just starting out, trying to build savings or an emergency fund can feel like a blow to the bank account in the short term.
Without ready-made retirement match 401(k) programs and automatic withdrawals from paychecks, freelancers need to have as much motivation to save as they do finding and landing jobs. The first step is to start saving now.
Here are four retirement plans to consider as a freelancer or self-employed worker:
1. Traditional or Roth IRA
This is the best option for those just starting to save who want to save less than $5,500 a year. You can also roll an old 401(k) into an IRA, if you have one. The limit is up to $5,500 (plus $1,000 catch-up contribution for those ages 50 plus). You’ll get a tax deduction on contributions to a traditional IRA, no immediate deduction for Roth IRA, and withdrawals during retirement are tax-free. There are no employee plans, so if you have employees, they can set up their own IRAs. This is one of the easiest ways to start saving as a freelancer because there are no special filing requirements.
Look into Betterment’s IRA options. Betterment takes a long-term approach to investing to help investors earn 2.66% more than typical investors, according to the company.
2. Solo 401(k)
This plan is a great option if you’re able to save a great deal of money each year, or if you’re trying to save more in some years and less in others. It’s best for a business owner or self-employed worker without employees.
This plan works just like a standard, employer-offered 401(k). Contributions are pre-tax and distributions after age 59 ½ are taxed. The contribution limit is up to $55,000 or 100% of income, whichever is less (plus $6,000 catch-up contribution for those ages 50 plus).
To understand the contribution rules, you will want to identify yourself as one of two people: an employer (of yourself) and an employee (also of yourself):
- As the employee, you can contribute up to $18,500 or 100% of compensation, whichever is less.
- As the employer, you can make an additional profit-sharing contribution of up to 25% of your compensation or net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself. The limit on compensation that can be used to factor your contribution is $275,000 in 2018.
As a freelancer you can open a solo 401(k) easily with most online brokers. Just take note, you’ll need to file paperwork with the IRS once your exceeds $250,000.
Once you start investing in a 401 (k) you can even use a service like Blooom to start optimizing your money.
3. SEP IRA
The SEP IRA (Simplified Employee Pension) is a type of traditional IRA for freelancers or small-business owners with no or few employees.
You can contribute the lesser of $55,000 or up to 25% of net income. Distributions in retirement are taxed as income and there is no Roth version of a SEP IRA.
Employers must contribute an equal percentage of salary for each eligible employee counted as an employee. So, if you contribute 10% of your own compensation for yourself, you must contribute 10% for each eligible employee.
You can open a SEP IRA just as you would a traditional or Roth IRA.
4. Savings Incentive Match Plan for Employees (SIMPLE IRA)
SIMPLE plans are a good option for individuals or small-business owners with a small number of employees. For small-business owners, SIMPLE IRAs allow them and their employees to contribute up to $12,500 annually and either 2% fixed contribution or 3% matching contribution. Workers older than 50 can get a $3,000 catch-up contribution. This plan offers upfront tax breaks and tax-deferred saving, so you don’t pay taxes until you withdraw money.
No matter which plan you choose to save with, it’s recommended that freelancers put 12% plus away into retirement, but there is one caveat: paying off debt should be a focus before saving for retirement.
If you’ve got a substantial outstanding balance on your credit card, pay that off first and then focus on saving.
Feature Illustration: Laura Caseley For The Money Manual