Personal Finance

How to Save For Retirement as a Freelancer

Feb 14, 2020

Most Americans aren’t saving enough for retirement. In fact, a whopping 75% percent of Americans don’t even know how much they will need to retire comfortably. Unfortunately, many of us put off saving for retirement, despite the fact that doing so could seriously compromise our financial futures.

As a freelancer, you may feel particularly overwhelmed by the concept of saving for your retirement. Because you are completely in charge of your own finances, your questions and financial needs are different from those of the average employee.

In this article, we will discuss why and how you need to save for retirement as a freelancer, as well as some options to consider in your decision-making process.

Why You Need to Save for Retirement

The premise of retirement is simple enough: you work hard in the present so that you will be able to live comfortably without a paycheck in the future. In reality, however, retirement is more complex, relying on your ability to put away money early and often. Many people stumble at this particular hurdle; indeed, 42% of Americans have less than $10,000 saved for retirement.

For many Americans, saving for retirement may seem like an impossible task due to their current financial situations. As a freelancer, you may find it especially difficult to plan for your future when you’re living contract-to-contract. You may even believe that you may never actually retire. However, there are several relatively simple ways that you can establish a foundation to protect your financial future.

The easiest way to save for retirement is to set up a retirement plan and start making contributions.

How to Set Up Your Retirement Savings

Freelancers have many options when it comes to saving for retirement. It’s important that you do your homework, as all retirement options offer something different and every person has different needs. Below we’ll outline a few of the options to consider when setting up a retirement account.

IRA

An IRA is an account set up at a financial institution with a specific purpose to save for retirement with tax-free growth. There are two main types of IRAs:

Traditional IRA: Contributions are tax-deductible and any earnings can grow to potentially be tax-deferred until withdrawn in retirement. Many retirees find themselves in a lower tax bracket, so the tax-deferral means the money may be taxed at a lower rate.
Roth IRA: Contributions are made after-tax, and funds may potentially grow tax-free, with tax-free withdrawals in retirement, provided certain conditions are met.

IRAs allow your savings to potentially grow more quickly than in a taxable account, and you can rollover any previous 401(k)s into an IRA. An IRA has a maximum contribution limit of $6,000. If you are just starting your freelancing career, an IRA may be the easiest solution for you.

Starting your IRA:

Opening an IRA account is simple. First, you need to ask yourself how involved you want to be in the management of your funds. If you want to choose investments for yourself, an online brokerage is a good way to go. If you want help managing your retirement account, consider a robo-advisor, which is a service that selects low-cost and risk-appropriate investments for you.

Once you have chosen a provider, the online signup process is fairly straightforward. You'll be asked to provide some general information, including your Social Security number, birth date, contact information, and employment details.

Self-Employed 401(k)

A self-employed 401(k) is specifically for those who own their own business or freelance with no employees. This works like a standard 401(k) plan, but it is specifically for the self-employed. Contributions can be made up to $56,000 and are made pre-tax. To be eligible, you must be a business owner with no employees. This plan is particularly attractive for those who can and want to save a great deal of money for retirement or those who want to vary how much they save each year.

A self-employed 401(k) is almost like having two versions of yourself contributing to your retirement. You, the employer, contribute up to 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. You, the employee, can also make contributions up to $19,000. As the employer and employee of your business, a self-employed 401(k) grants you the flexibility to make large contributions.

Starting your self-employed 401(k):

You can open a solo 401(k) at many online brokers. Choose your online provider, provide your Employer Identification Number, fill out the forms, and you’re all set. Note that you’ll need to file paperwork with the IRS each year once you have more than $250,000 in your account.

SEP IRA

Similar to the self-employed 401(k), a SEP (simplified employee pension) IRA has high contribution limits and allows for fluctuations in contributions. Contributions are tax-deductible, and investments can grow tax-deferred over time. A SEP IRA is often attractive to those who are self-employed or own a small business.

A SEP IRA has a maximum contribution of $56,000 or up to 25% of compensation or net self-employment earnings, with a $280,000 limit on compensation that can be used to factor the contribution. Net self-employment income is net profit less than half of your self-employment taxes paid and your SEP contribution, with no catch-up contribution.

You can deduct the lesser of your contributions on your tax return. In retirement, distributions are taxed as income.

Starting your SEP IRA:

Setting up your SEP IRA is simple. First, you’ll need to choose an online provider. Then, there are two steps you’ll need to take:

Create a formal written agreement. You can do this with IRS Form 5305-SEP or through your account provider.
Give eligible employees information about the SEP IRA. You can give them a copy of IRS Form 5305-SEP or get similar information through your account provider.

SIMPLE IRA

A SIMPLE IRA stands for “savings incentive match plan for employees,” which means that a SIMPLE IRA is intended for small business owners with a staff. A SIMPLE IRA works similarly to a traditional IRA. Contributions are tax-deferred, meaning the amount you save up to your contribution limit reduces your taxable income for the year. Investment growth is also tax-deferred until you start taking distributions in retirement. The contribution limit is $15,000.

In other ways, SIMPLE IRAs are like 401(k) plans: eligible employees indicate how much of each paycheck they want to contribute to the account, and the money is automatically diverted into the worker’s individual investment account.

For those with employees, a SIMPLE IRA requires all employees to make matching contributions. A SIMPLE IRA may be best suited for those small business owners with a small staff. Other plans such as the SEP IRA and self-employed 401(k) offer high contribution limits and are better suited for the self-employed.

Starting your SIMPLE IRA:

Setting up a SIMPLE IRA is similar to a traditional IRA. Choose your online provider, fill out the IRS form, and provide all the necessary documents.

Don’t Forget about Taxes

Taxes for your retirement plan don’t have to break you financially, but you should be strategic about your plan. If you’re not careful, you could end up paying more in taxes than necessary depending on your retirement plan. Be sure to reach the available options for each type of retirement plan. Many retirement plans offer tax benefits to the contributor now, with some contributions being made pretax or tax-deferred.

Your contributions (except in the case of a Roth) are tax-free, and the investment interest that the account earns is nontaxable until you withdraw it. You can even move funds from one account to another, or keep the account when you change employers. We recommend researching the tax options available to you and talking to your accountant about the options best suited to your particular case.

Knowledge Is Power

Whether you’re launching your freelance career or looking to make retirement savings a priority, we hope this overview helped to provide you with the tools you need to further research which retirement option is right for you. Saving for retirement is less scary when you have the information you need to succeed.