Freelancers, don’t forget about retirement! Blogger Tess Wicks runs down retirement savings options for the self-employed Grownup.
Self-employment offers the freedom to set your own schedule, choose your type of work, and work independently. But while top priorities of the self-employed are to make the sale and figure out where the next source of revenue is coming from, our employer-sponsored peers have a consistent paycheck and retirement plans that can typically grow with every pay period.
Being self-employed comes with a great deal of responsibility and compromises. Not only must you report your income and pay quarterly taxes, but the cost of financial benefits typically received through an employer all fall to you as well. According to a 2015 study from TD Ameritrade, more than half of self-employed individuals admit they’re behind in saving for retirement, and most don’t have a specific retirement savings goal in mind.
We can’t ignore the importance of funding a retirement savings account. Because even though you swear you’ll be working well into your 80s, having a cushion for emergencies or a change of heart is a wise move.
Just as you’ve made it a priority to establish your own career and make your own money, now it’s time to prioritize investing to help provide yourself an income in the future.
The Immediate Benefits of Saving for Retirement
As a self-employed person, you’re responsible for paying taxes on a quarterly basis. This also means you get to write off significant business expenses to reduce your tax liability. A tax-advantaged retirement account just so happens to be one of the top tax deductions a self-employed individual can make.
Saving sooner rather than later means you also benefit from compound interest. Compound interest works most favorably on the earliest contributions to investment accounts, as returns multiply day-after-day and year-after-year. Investing early should help you achieve your retirement savings goals much quicker.
How Much Do You Need for Retirement?
When it comes to a retirement savings goal, one size definitely does not fit all. Your savings goal will largely depend on when you plan to retire, how much money is needed to support your lifestyle every year in retirement, where you will live, and how long you plan to live for. Play around with a retirement calculator to figure out what percentage of income or set dollar amount you should be saving each month to ensure you won’t outlive your retirement savings.
Retirement Plans for the Self-Employed
There are three types of tax-advantaged retirement accounts specifically for the self-employed: SEP IRA, Solo 401k, and SIMPLE IRA.
A Simplified Employee Pension (SEP) IRA is the easiest and most flexible plan to set up. An SEP does not require a minimum contribution and allows the participant to wait until their tax deadline (April 15 or October 15 with an extension) to make a contribution for the prior tax year.
The contribution limit for a SEP IRA is the lesser of 25 percent of net earnings from self-employment or $53,000 in 2016 ($54,000 in 2017). SEPs do not have catch-up provisions, so an individual cannot contribute more if they are older than age 50, and withdrawal before age 59 1/2 may be taken, but is subject to a 10 percent penalty fee and will be taxed. It’s important to note that if you have employees and a SEP IRA plan in place, everyone’s contribution must be the same percentage of salary.
A Solo 401k, also called an individual 401k or one-participant 401k plan, is the traditional 401k plan for a business owner with no employees or the individual and his or her spouse. The plan operates exactly as a traditional plan does, with a contribution limit up to $18,000 in 2016 and 2017 and an additional $6,000 if 50 or older.
Unlike the Traditional 401k, the Solo 401k allows for an additional contribution of up to 25 percent of net earnings up to a max of $53,000 in 2016 ($54,000 in 2017). Loans can be drawn from a Solo 401k for up to half the balance or $50,000, whichever is less, and early withdrawal is not permitted unless there is proof of a significant financial need.
The Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA) is for sole proprietors or employers with fewer than 100 employees. An employer is required to contribute a 2 percent fixed contribution, or 3 percent matching contribution for their employees. This plan is generally cheaper than a traditional retirement plan–like a 401k–so it may be favorable if you have a growing business and want to provide a small retirement benefit to future employees.
Tax-deductible contributions must be made within 30 days after the last day of the tax year and are capped at 100 percent of net earnings up to $12,500 or $15,500 if age 50 or older. The rules for borrowing from a SIMPLE IRA are similar to the SEP IRA; however, a higher withdrawal fee is applied if done within the first two plan participation years.
Employer-sponsored retirement plans are so successful because they automate the entire process for their employees by taking the contribution before the employee sees their paycheck. “Out of sight, out of mind” is a true cliché in the world of saving money, and although managing the business expenses feels difficult enough, making retirement savings a priority as a self-employed person is vital for your financial future.
Set up your retirement account to automatically withdraw a set dollar amount or percentage of deposits from your bank based on the monthly contributions you determine from the retirement calculated. Work with a financial advisor or utilize a robo-advisor to make your asset allocations automatically adjust as you age. By forcing your retirement savings to happen automatically, you’ll create a habit of taking money out of your business to be invested in your retirement. This is one of the best things you can do for your business, and your future self will thank you.
Tess Wicks is a personal finance freelance writer based in Chicago. She is the voice behind her personal finance podcast and blog, dedicated to educating and empowering Millennial women to take control of their finances. Follow her on Instagram and Twitter.
Any third-party resources or websites referenced above are not under Society of Grownups control. Society of Grownups cannot guarantee and are not responsible for the accuracy of the resources, websites, or any products or services available through such resources or websites.
While Society of Grownups hopes the information is useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. All investing has risk, including the possible loss of assets. If you need recommendations geared to your personal financial situation, schedule time with a financial planner.