One of the biggest financial risks you take as a freelancer is your retirement. Many traditional jobs offer contributions toward your retirement savings, or at the very least, incentive to save for the future. Unfortunately, in all the financial upheaval of transitioning or starting an independent work life, a lot of us tend to forget about planning for the future.
I had a chance to get some input from RetirementSavvy’s James C. Molet about ways that you as a freelancer should be addressing your retirement. Read through and you’ll learn the difference between retirement options, what you have access to, as well as get some great advice on setting up your “ideal” freelancer retirement plan.
What financial mistake do most freelancers make when addressing their retirement?
I imagine they make the same common mistakes as everyone else: borrowing from retirement plans, not starting early enough, not saving/investing enough and not developing a comprehensive plan.
Of course the impacts to freelancers are often more significant as they don’t have the stability that comes from a steady paycheck and they are on their own with respect to retirement planning as they don’t have access to retirement savings infrastructure that’s built into most big companies. Perhaps more so than those working a traditional 9 to 5, freelancers have to educate themselves and become financially savvy. Not doing so is a significant mistake.
SEPIRAs vs. Traditional/Roth IRAs …what should freelancers know about the differences? Do you recommend 401(k)s and 403(b)s for self-employed people at all?
First, note that a 403(b) is a retirement plan for certain employees of public schools, employees of certain tax-exempt organizations and certain ministers. Therefore, this type of retirement plan is not an option for the self-employed unless they fall into one of those categories.
With respect to retirement plans for the self-employed, the three most commonly used options are the Simplified Employee Pension – Individual Retirement Arrangement (SEP – IRA), the 401(k) and the Savings Incentive Match Plan for Employees (SIMPLE IRA Plan).
Basic highlights of each:
Simplified Employee Pension (SEP)
- Self-employed can contribute as much as 25% of their net earnings from self-employment (not including contributions for themselves), up to $53,000 for 2015.
- Self-employed can make salary deferrals up to $18,000 in 2015 (plus an additional $6,000 in 2015 if 50 or older) either on a pre-tax basis or as designated Roth contributions.
- Self-employed can contribute up to an additional 25% of their net earnings from self-employment for total contributions of $53,000 for 2015 including salary deferrals.
Savings Incentive Match Plan for Employees (SIMPLE IRA Plan)
- Self-employed can put all their net earnings from self-employment in the plan: up to $12,500 in 2015 (plus an additional $3,000 in 2015 if 50 or older) in salary reduction contributions and either a 2% fixed contribution or a 3% matching contribution.
There isn’t necessarily a right or best option. Various factors will determine which option works best for each individual. I highly recommend those interested in establishing a self-employed retirement plan refer to the IRS page for Retirement Plans for Self-Employed People.
For those who already have retirement savings and are considering using them as an emergency fund to get them through the rough start of freelancing…what are your thoughts?
Don’t. I always suggest that people avoid using retirement savings for anything other than retirement. Once money is committed to a retirement account, there it should remain until it is withdrawn in retirement as part of a comprehensive withdrawal (decumulation) plan.
An emergency fund – often referred to as a rainy day fund – should be a cash account (savings or checking) that is used only in the event of an emergency, to fill critical financial gaps, or meet unexpected expenses. It is immediate access to cash that allows someone to take care of unforeseen circumstances without impacting the money they have committed to saving and investing.
Can you condense what an “ideal” freelancer retirement plan might look like?
I believe a one-size, condensed ‘ideal’ retirement plan, for a freelancer or anyone else is not really possible. However, the actions that should be taken and the basic components of a solid retirement plan can be easily summarized:
- Develop a Spending Plan (aka a Budget)
- Minimize Debt
- Develop an Emergency Fund
- Determine Retirement Goals
- Invest – Aggressively as Possible – in a Retirement Account
- Develop Multiple Streams of Income, Current and Retirement
What kind of savings/retirement goals do you recommend for freelancers?
I don’t believe the retirement goals for freelancers should be any different than those who work more traditional 9 to 5 jobs. The key for any individual that is serious about retirement is understanding all the factors that go into determining how much is required for a satisfying retirement and then developing a plan to support that goal.
In my book, RENDEZOVUS WITH RETIREMENT: A Guide to Getting Fiscally Fit, I identify the relevant factors that must be considered and lay out detailed steps on how to develop a retirement plan, utilizing a spreadsheet – which contains all the necessary formulas – that I developed.
As an example, assume you have an individual that is 30 years old, wants to retire in 30 years (at age 60), currently has $35,000 saved, will not be receiving any type of defined benefit plan (aka pension), anticipates an average return of 6% annually on their investments and has determined that they will need a retirement income of $55,000. How large does the nest egg need to be at age 60? How much is needed to save each month for the next 30 years to get there?
The answer to the first question, using the 4% rule, is $1,375,000.00 (55,000 / .04). The answer to the second question is more complicated and requires a good compound interest calculator or something like the spreadsheet I developed. When all those relevant numbers are plugged in, the answer is $1,167.50 each month or $14,010.00 annually.
A change to any one of those factors noted above (i.e. age, current savings, anticipated rate of return on investments, years until retirement and desired retirement income) will change the outcome. That is why it is critical that individuals understand each factor and how they relate to one another during the course of developing – and managing – a retirement plan. It should also be remembered that the retirement plan is not a once and done proposition; it is absolutely dynamic. As ‘life’ (e.g. children, job loss, promotion, changed goals, divorce, etc.) impacts the individual, those impacts have to be reflected in the retirement plan.
Any additional advice?
Each individual should educate themselves to the greatest extent possible. A satisfying retirement doesn’t just happen and it isn’t something for which you want to rely on someone else, spouse or otherwise.
A quote that serves as kind of a philosophical and life guide for me and one that I’m sure freelancers can appreciate is from Les Brown — “I’d rather aim high and miss, than aim low and hit.”
If you’d like to contact James, you can reach him at firstname.lastname@example.org