Planning for Retirement When You’re Self-Employed

Most people want to retire at some point in their lives. In the United States, that typically requires individuals to put aside money during their careers to supplement Social Security. This is especially true with there being concerns about the financial health of the Social Security program.

Furthermore, many in today’s economy don’t enjoy the employer-provided benefits of the past, such as pension plans. Self-employed people even more so need to do their own work in order to prepare for retirement. Even thougt it’s not a cakewalk, there are strategies to plan for retirement when you’re self-employed. 

Make Saving Part of Your Budget

The word budget evokes negative visceral feelings for a lot of people. Thinking about your finances can be daunting—especially if you’re just managing to make ends meet. This can often be the case for people who are self-employed, since you take on a lot more responsibility when working for yourself. But coming up with a budget is an essential part of your financial health. 

Of course, you’re going to budget for your basic living expenses like food and shelter. You’ll also want to ensure you have some money for insurance, transportation, and other things that you need to get by in the world. Then, you’ll want to budget a bit of your income to leisure—eating out, vacation, memberships, or other want-based expenses.

However, saving also needs to fit somewhere into your budget plan. Many experts say people should try to save 25 percent of their gross pay in their 20s. Most people in their 20s would say that’s ridiculous, particularly when student loan debt is so prevalent with young people today. Regardless, you should try to set aside a certain percentage of your income each month to savings. There are even tools that can help you calculate how much you’ll have at retirement if you put away a certain amount each month.  

Create a Self-Employed Retirement Account

While putting money into savings is a great first step, you probably don’t want to just have it all sitting in a savings account. If you just keep your savings there, it won’t grow. It will even start to lose its value over time as inflation makes it worth less and less. The best idea is to put your money into some form of retirement account. There are several options out there, even a few specifically designed for self-employed people. 

SEP IRA

This is an individual retirement account created for self-employed individuals. It’s best for those who are sole proprietors, or those with few employees—as you must match your own contributions for your employees on a percentage basis. You can contribute up to $56,000, or 25 percent of your self-employed earnings—whichever is less. It’s also possible to deduct your contributions on your taxes—though you pay taxes on the distributions in retirement as income. 

Solo 401(k)

This works like a 401(k) you would have through working for a company, but it’s specifically created for self-employed individuals. It’s important to note off the bat that this option isn’t viable for people who have employees. But you can have your spouse contribute to the plan. The solo 401(k) differs from the SEP IRA in that you can contribute as both an employee (up to $19,000, as with a typical 401(k)) and as an employer (25 percent of your self-employed income) up to a total of $56,000. This allows you to potentially contribute more than you can with a SEP IRA. 

Roth IRA

A Roth IRA is often cited as one of the most sensible ways for anyone to put away extra money for retirement. This is especially true for self-employed individuals—particularly if you aren’t making a massive income. Unlike many retirement accounts, you don’t defer taxes with a Roth IRA. However, you don’t have to pay taxes when you take the money out in retirement, or capital gains taxes. This can allow savers to build quite a robust retirement account without having to contribute as much. There’s a $6,000 annual contribution limit on Roth IRAs.     

Don’t Carry Too Much Debt

Debt is unfortunately an unavoidable aspect of life for many people. However, there are drastically different kinds of debt, and approaches to tackling it. First, it’s wise to consider what are good and bad forms of debt. Good debt can improve your financial situation. For example, a mortgage or college degree will require debt. But the payoffs of building equity and making yourself more attractive to employers may be worth the cost. Plus, good debt typically comes with lower interest rates. 

Bad debt typically doesn’t provide any return for you and comes with a much higher rate of interest. Credit cards are an example of potentially bad debt. Co-founder of Freedom Debt Relief Andrew Housser notes that buying things with store credit cards can seem like a good idea when they have perks like cash back. But the high interest rates can more than eliminate the rewards if you carry a balance. 

Bringing a significant amount of debt into retirement can quickly erode all your savings. Be prudent by coming up with a plan to pay off your debt before you retire. The most cost-effective method is to pay off your highest interest rate debt first. This is called the avalanche method. However, studies have shown that “snowballing” or paying off your debts from smallest balance to largest is often more effective because people respond better to making clear-cut progress. 

Decide What You Want from Retirement

The amount you need to prepare entirely depends on what you plan on doing in your retirement. For instance, travelling the world with your spouse and leaving something for your children will require you to consistently save and plan throughout your working life. On the other hand, people with more frugal aspirations, or who plan on working later in life because they love their jobs, won’t need to put nearly as much away. No matter your goals, it makes sense to take time to understand how much you need to save in order to achieve them. 

Planning for retirement can be an intimidating thing. This is especially the case when you’re self-employed, and don’t have the security of an employer-provided retirement package. Fortunately, there are resources that exist to help self-employed people prepare for life after work.

This is a collaborative post.