Retirement for Freelancers and Self-Employed People
So you work for yourself: congratulations! You have decided to be your own boss and make the decisions necessary to maintain or grow your freelancing business or sole proprietorship. You're probably so busy doing your work as well as doing the paperwork, marketing your business, and maintaining your workspace that you couldn't possibly do one more thing. But there is one very big thing that you musn't forget: retirement planning.
You no longer have a human resources department to handle all the details of your pension. Heck, you no longer have a pension! It's all DIY from here. Luckily, self-employed folks have some good options for retirement savings accounts.
Types of Retirement Plans for Self-Employed Individuals
As a self-employed individual (whether a freelancer, independent contractor, or sole proprietor of a small business) in the U.S., you have some of the same options that employees of large corporations do. However, some of these options, such as profit-sharing or a defined benefit plan, necessitate a lot of paperwork, fees, and even professional assistance. Let's focus on plans you can start on your own with a few simple forms or a little help from the bank.
Examples: How Much You Can Save With Each Plan
Example 1: Marisol is a 40-year-old experienced freelance writer who is an independent contractor. She has no employees, and grossed $65,000 in 2020. If we plug that into a self-employment contribution calculator, we see that her net self-employment income is approximately $60,400. She could make these maximum contributions:
- SEP-IRA: $12,080
- SIMPLE IRA: $13,905 ($13,500 + 3% employer contribution)
- Solo 401(k): $24,375 ($19,500 + 25% employer contribution)
Example 2: Harold is a 55-year-old sole proprietor of a taxi business with no other employees. He grossed $50,000 in 2020, for a net self-employment income of a little less than $46,500. His approximate maximum contributions would be approximately:
- SEP-IRA: $9,300
- SIMPLE IRA: $16,905 ($13,500 + 3% employer contribution+ $3,000 in catch-up contribution)
- Solo 401(k): $30,875 ($19,500 + 25% employer contribution + $6,500 in catch-up contribution)
A SEP-IRA allows you to put away up to 25% of your net (not gross) self-employment income, up to a maximum of $53,000 (as of 2016).
- You can contribute to both a SEP-IRA and a Roth IRA if you are eligible for a Roth, or to an employer-sponsored 401(k) if you still have a day job.
- You can fund your account for the calendar at any time until your taxes are due (usually April 15 of the following year), so you can make a larger or additional contribution if you made more money than you thought you would. Conversely, if you made less than planned, you can skip your contribution for the year or contribute a smaller amount.
- You can set up a SEP-IRA by filling out a simple form; your bank or brokerage firm can walk you through the process over the phone.
If you are small business owner, you can also use a SEP-IRA to make tax-deductible "employer contributions" to eligible employees. You must give all eligible employees the same percentage, so your flexibility is somewhat limited.
Small business owners (with fewer than 100 employees) might be better off instituting a SIMPLE (Savings Incentive Match Plan for Employees) IRA. As the name implies, it is easy to implement (requiring primarily a form that your financial services firm can help you with and an annual notice to employees) and provides your employees an incentive to save their own money. As the employer, you are obligated to match your employees' savings dollar for dollar up to 3% or give a 2% contribution across the board.
If you own your own business but do not have any other employees, you are still eligible to create a SIMPLE IRA for yourself. You may want to do this if your income is low, because while the elective deferral contribution limit in 2020 is $13,500, that money can be up to 100% of your compensation. You can also make catch-up contributions of up to $3,000 if you are 50 or over, which you cannot do in a SEP-IRA.
If you're willing to trade a little more paperwork for the option of contributing more money, consider an individual 401(k). As an employer for yourself, you can contribute up to 25% of your net self-employment income, but you can also make a contribution of up to $18,500 (in 2020) in your role as an employee. The two must not exceed $57,000 together, although you are allowed a $6,500 catch-up contribution if you're over 50. Your spouse (who works for your business) is also eligible to participate. The downside? Your taxes get more complicated, there are no ready-made generic forms to help you start up the plan, and you'll need to file an annual report with the IRS once the assets in your plan reach a certain threshold (currently $250,000).
Comparison of Retirement Plan Types
Up to 25% of net self-employment income, but not more than $57,000
Up to 100% of self-employment income, but not more than $13,500
Up to $19,500 as an employee contribution, plus up to 25% of net self-employment income, not to exceed $57,000 combined
Difficulty of setup and maintenance:
very easy: generic forms available; no further paperwork
easy: generic forms available; required annual notice to employees
more complex: significant record-keeping and paperwork necessary; higher administrative fees
Best plan for:
independent contractor or very small business owner
small business owner (no additional employees up to 100 employees)
sole proprietor and spouse (if employed by the business)
Catch-up contributions for those 50+:
Small business employee coverage requirements (if appropriate):
employees who are at least 21 years old, have been employed for 3 of the past 5 years, and earned at least $600 per year.
employees who have earned income of at least $5,000 in the past 2 years and are likely to do so again this year
covers only business owner; plan must change if employees other than spouse are hired
you as employer can decide whether to contribute and how much without any paperwork (all eligible employees—even if you're the only one— must receive the same percentage)
you as employer can match employee contributions (including your own) of up to 3% of salary or contribute a 2% match to all eligible employees; if you want to change the percentage or type of contribution, you must do so in writing before implementing the change
you as employer can change the percentage of the company's match, plus you as employee can change your contribution, but both require paperwork
Start Saving for Retirement Today
Don't delay! Choose the plan that's right for you and get started as soon as possible. Due to the magic of compounding interest, the younger you are when you start, the less you'll have to pull out of your paychecks to reach your goal. Even if you're brand-new to the freelance life or your business has only just become eligible, open a plan and start contributing. It will become a habit, you'll see tax benefits, and you'll end up with a nest egg you wouldn't otherwise have had.
The IRS Can Help You With Retirement Planning
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.