Build Your Retirement Plan

The benefits of self-employment are numerous, but so are the drawbacks. One of the most important is the need to plan for retirement entirely on your own. You are responsible for creating a satisfying quality of life after retirement. The sooner you begin, the better when making that life. Fortunately, there are several retirement plans available to self-employed individuals.

According to a 2019 study conducted by the Freelancers Union and Upwork, 57 million freelancers in the United States, increasing 53 million reported in 2014. According to the report, this accounts for 35% of the total workforce in the country. In 2020, the percentage of freelancing at any point during the year increased from 35% to 36%.

This entrepreneurial spirit is admirable. However, it is less respectable that 30 percent of self-employed people save for retirement only sporadically. 15 percent don’t save at all. That is an issue. You are busy self-employed, but retirement savings must be a priority.

Saving is hard

Any self-employed person will recognize the reasons for not saving for retirement. The most common are:

• A lack of consistent income
• Getting rid of significant debts
• Health-care costs
• Education costs
• Expenses associated with running a business

Like everything else an entrepreneur does, setting up a retirement plan is a do-it-yourself project. There are no matching contributions, no company stock shares, and automatic payroll deductions.

Your earnings determine the amount you can put into your retirement accounts. Hence, you’ll need to be highly disciplined when contributing to the plan.

Even though freelancers face unique challenges when saving for retirement, they also have extraordinary opportunities. Funding your retirement account, as well as any time or money spent on establishing and administering the plan, can be considered business expenses. Even better, a retirement account allows you to make pretax contributions, lowering your taxable income.

How a Solo 401(k) Works

A one-participant 401(k), as the IRS officially knows it, is also known as a solo 401(k), solo-k, uni-k, or individual 401(k) (k). It is only available to sole proprietors with no employees other than a spouse who works for the company.

The one-participant plan closely resembles many more prominent companies’ 401(k)s, right down to the annual contribution limits. The main difference is that you can contribute both as an employee and as an employer, giving you a higher contribution limit than many other tax-advantaged plans.

So, if you participate in a traditional corporate 401(k), you would make investments as a pretax payroll deduction from your paycheck. Moreover, your employer could match those contributions up to a certain amount. You receive a tax deduction for your donation, and your employer gets a tax deduction for its match. A one-participant 401(k) plan allows you to contribute as an employee (an elective deferral) and business owner.

Elective deferrals for 2021 can be max to $19,500, or $26,000 if you are 50 or older ($20,500 or $27,000 in 2022). As of 2021, total contributions to the plan cannot exceed $58,000, or $64,500 for people aged 50 and up ($61,000 or $67,500 in 2022). If your spouse works for you, they can also contribute the same amount you can match. So you can see why the solo 401(k) plan has the highest contribution limits of the plans.

Some paperwork is required, but it is not overly burdensome.

A business owner must work with a financial institution to establish an individual 401(k), which may impose fees and limits on the types of investments available in the plan. Some plans may limit you to a specific list of mutual funds. However, with a bit of research, you can find many reputable and well-known firms that offer low-cost plans with a lot of flexibility.

According to James B. Twining, CFP, founder and wealth manager of Financial Plan, 401(k)s are generally complex plans with significant accounting, administration, and filing requirements. However, setting up a solo 401(k) is quite simple. There is no need to file anything until the assets exceed $250,000 in value.

How a SEP IRA works

A SEP IRA, also known as a simplified employee pension, is a traditional IRA. It’s an excellent choice for sole proprietors because it’s the simplest to set up and run. However, it also allows for one or more employees.

Employees do not contribute to a SEP IRA; instead, the employer does. In contrast to the solo 401(k), you would only contribute while representing your employer. You can contribute up to 25% of your net earnings (defined as your annual profit less than half of your self-employment taxes), with a maximum contribution of $58,000 in 2021.

The plan’s simplicity and flexibility make it ideal for one-person businesses. However, there is a catch if you have employees.

How a SIMPLE IRA works

The SIMPLE IRA follows the same investment, rollover, and distribution rules as a traditional or SEP IRA except for lower contribution thresholds. You can put all of your net self-employment earnings into the plan, up to a maximum of $13,500 in 2021, plus an extra $3,000 if you are 50 or older.

Employees can contribute in the exact annual amounts as employers. However, as the employer, you must contribute up to 3% of each participating employee’s income to the plan each year, or a fixed 2% contribution to every eligible employee’s income whether they contribute or not.

Even if you can’t afford to save much at first, it’s critical to begin saving for retirement as soon as you start earning money. Because of the miracle of compounding, the sooner you start, the more you’ll accumulate.

Assume you save $40 per month and invest it at a 3.69 percent rate of return, which the Vanguard Total Bond Market Index Fund earned over ten years ending in December 2020. Using an online savings calculator, an initial investment of $40 plus $40 per month for 30 years equals slightly less than $26,500.

To sum up

Developing a retirement strategy is critical for freelancers because no one else is responsible for your retirement but you. As a result, your mantra should be to pay yourself first.

Many people consider retirement money to be the money they save if there is any money left over at the end of the month or year. According to David Blaylock, CFP, Origin’s head of advice and planner compliance, this is paying yourself last. Paying yourself first means putting money aside before doing anything else. Before you spend any discretionary money, try to set aside a portion of your income on the day you get paid.