When you start out as a freelancer or open your small business, retirement is likely the last thing on your mind. Keeping food on the table is a higher priority. That doesn’t mean saving for retirement shouldn’t become important once you’ve established yourself in a career. You’ll likely need more than a monthly Social Security check to support yourself in retirement, and there are options for saving that rival matching contributions from an employer’s 401(k) if you contribute regularly and invest wisely.
Simplified Employee Pension Plan
The Internal Revenue Service allows you to annually put away as much as 20 percent of your net income from self-employment into a Simplified Employee Pension Plan. Better known as a SEP-IRA, the permitted contribution limit changes each year based on cost-of-living adjustments. For 2016, self-employed individuals may put away as much as $53,000, based on a net income limit of $265,000. Contributions are tax-deductible, lowering your taxable adjusted gross income for the year. Other than contribution limits, an SEP-IRA functions in the same way as a traditional IRA. Withdrawing funds before you reach the age of 59 1/2 results in penalties, and you must start withdrawing funds by the time you reach 70 1/2. SEP-IRAs are easy to set up. Contact your bank, broker, mutual fund advisor or other qualified financial institution to get started. The deadline for making contributions is April 15 of the following tax year, although it can be later if you have filed for an extension of your tax return.
If freelancing is only part of your income, and you contribute to an employer-sponsored 401(k) at work, you can still open an SEP-IRA and put away up to 20 percent of your freelance net income.
Roth IRAs
While you can’t deduct contributions to Roth IRAs, you aren’t taxed on the distributions once you start making withdrawals in retirement, unlike SEP or traditional IRAs. There’s no mandatory age limit at which you must start making withdrawals — you don’t ever have to do so.
You may contribute up to $5,500 of your earned income annually to a Roth IRA if meeting the income eligibility limits. Those over 50 may contribute up to $6,500. For 2016, single filers with an adjusted gross income of up to $117,000 may contribute to a Roth IRA, while those earning $117,000 to $132,000 may make a partial contribution. Single filers with an AGI of $132,000 are ineligible. Married people filing jointly may make a full contribution with an AGI of up to $184,000. Those with an AGI between $184,000 and $194,000 may make a partial contribution, but couples with an AGI above $194,000 are ineligible.
Solo 401(k)
Another retirement option for freelancers is the solo 401(k), also known as an individual 401(k) or self-employed (401)k. You can include your spouse in a solo 401(k). These plans fall under the same IRS rules as employer-sponsored 401(k) plans. For 2016, freelancers under age 50 may contribute up to $18,000 of elective deferred earned income to a solo 401(k), and up to $24,000 if over 50. Freelancers may also contribute up to 25 percent of earned net income as an employer contribution, but the amounts of employee and employer contributions can’t exceed $53,000 for individuals under age 50, and $59,000 for those over 50 in 2015. A brokerage, bank or other financial institution can help you set up a solo 401(k).
Saving for retirement is important, especially for sole proprietors and freelancers as they must have the discipline to make regular contributions rather than having money taken out of paychecks. Once your solo career offers you some disposable income, allocate as much as possible to retirement savings. These contributions save on taxes in the short run and ease you into a comfortable retirement in the long run.
—Jane Meggitt