How should freelance workers save for retirement?
Grant Blindbury
More and more Americans are saying that the freelance life is the life for them. A whopping 53 million Americans consider themselves to be full-time freelancers – an all-time high. With the flexibility and freedom of freelance life also comes challenges, such as determining how to save for retirement without the traditional backing of a full-time employer.
About 34 percent of the U.S. workforce is now freelance, according to a nationwide survey last summer by the Freelancers Union and Elance-oDesk online job marketplace. With the onus on freelancers to handle their own retirement planning, how are freelancers doing?
Not well.
Tom Egan, a graphic designer in his 50s living in Jersey City told CNBC that he will likely have to “work until I drop dead.”
Egan mostly invests in mutual funds but also has some individual stocks. He funds his accounts in the early spring, but only if he has any money left after paying his taxes.
"I’ve missed quite a few years since 2000," Egan said.
Egan’s missed-years problem highlights one big issue for freelance workers — they don’t get the dedicated employee match that many corporations offer on 401(k) plans, which doubles the amount of money workers can sock away for retirement. And for the freelancers who divert some of their savings to an emergency fund, they are left with even less to put into a retirement account on an annual basis.
"The biggest challenge freelancers face when it comes to retirement is the feast-or-famine nature of their income," Dan Lavoie, director of strategy at the Freelancers Union, told CNBC. "One month you might be flush from a big project. But the next, you’re looking for a new gig and prospecting. It’s hard to know how much to put away or when you can afford to put it away. It’s important to remember that every little bit helps."
According to a CNBC article, there are three main types of retirement plans for the freelancer to consider:
Simplified Employee Pension (SEP)
These are traditional IRAs that typically only require a one-page form at most banks and brokerages, and they can be opened and funded right up until your tax-filing deadline. You can contribute 25 percent of your net self-employment income, up to $53,000 annually. These plans do not allow for Roth IRAs, wherein contributions are initially taxed but eventual withdrawals are tax-free.
Solo 401(k)
Also known as Individual 401(k)s, these allow $18,000 in annual contributions, plus 25 percent of net earnings from self-employment, up to $53,000 annually. People who are 50 years or older and looking to catch up on their retirement savings can put in an extra $6,000 annually. These plans can be funded on a pretax basis or post-tax as Roth contributions, and they allow for pre-retirement access through loans and hardship distributions. They must be set up by Dec. 31 of the preceding tax year.
Savings Incentive Match Plan for Employees (SIMPLE IRA)
SIMPLE plans are typically for small-business owners, but they also work for individuals, especially those who are considering eventually expanding their business with outside hires. As with the SEP and non-Roth 401(k), this plan offers upfront tax breaks and tax-deferred saving. Neither you nor your employees pay taxes until you withdraw money. Small business owners and their employees can contribute up to $12,500 annually (plus an extra $3,000 for those 50 or older) plus either a 2 percent fixed contribution or a 3 percent matching contribution.
It is not uncommon for workers to accumulate several retirement plans over the years, such as a corporate-sponsored 401(k) from a former employer. If these plans have good investment options and low fees, there is no need to roll them over into a combined account. One catch is that 401(k) account balances below $5,000 are not guaranteed placement in a given plan — a plan sponsor could ultimately cut the participant a check for the balance if the participant does not roll the money over into another 401(k) or IRA account.
The advantage to staying in a 401(k) rather than rolling over to an IRA, if allowed, is that 401(k) plan account fees and underlying fund-management fees are typically lower than individual IRA fees — though 401(k) plans at very small companies may not be any more cost-attractive than an IRA. The downfall to staying in a company 401(k) is that IRAs are more flexible when it comes to distribution policies, including emergency withdrawals.
One big issue that many freelancers face is how to balance paying off debt while saving for retirement. Bob Glovsky, vice chair of the Boston-based registered investment advisory firm The Colony Group, told CNBC that he recommends putting 20 percent of freelance income toward either retirement savings or paying down outstanding debt. He also recommends individual 401(k) plans as generally the best bet for independent contractors due to their flexibility and high savings limits.
The freedom of freelance life does come at a price, but saving for retirement and paying down debt is possible with the right strategy and saving diligence and consistency.