How to Save for Retirement if You’re Self-Employed
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How to Save for Retirement if You’re Self-Employed

Nearly 30% of Americans had some kind of self-employment in 2019, according to Gallup and Intuit’s Gig Economy and Self-Employment Report, while 14% relied on self-employment as their primary income. While COVID-19 has likely produced significant temporary changes, the growth in self-employment and the gig economy remains intact.

There are many reasons for choosing self-employment, including greater flexibility or income potential, but one of the most common downsides is the lack of an employer-sponsored retirement plan. Unlike an employee that has a 401(k) or pension plan, self-employed individuals are on their own to save for retirement.

Let’s take a look at some of the best ways for self-employed individuals to save for retirement.

Be sure to check out the Retirement Channel to learn more about retirement planning concepts and strategies.

Determine How Much You Need

There is no shortage of online calculators to help you determine how much to save for retirement. In most cases, financial advisors recommend saving enough to replace 70% to 90% of your pre-retirement income through savings and Social Security. However, if you have pre-existing health conditions or other expenses, you may need to save even more.

The amount that you need to save for retirement also depends on the withdrawal strategy that you use and whether you want to leave money to heirs. For instance, some financial advisors recommend that you draw down four percent each year in retirement, but that amount depends on your projected lifespan and the amount you want to leave your loved ones.

Once you know how much you need in retirement, you can work backwards to determine how much you need to save each month right now to achieve the desired goal. These calculations involve making some assumptions, such as the average rate of return, inflation rates, and rates of return in retirement with a conservative portfolio, among other things.

Choose the Right Type of Account

There are several different types of retirement accounts designed to help self-employed people save for retirement in a tax-advantageous way. While you won’t receive the matching contributions that many employees receive, you can still benefit from the tax deductions associated with contributions or tax-free growth in the case of Roth accounts.

The most popular accounts include:

  • Traditional or Roth IRA: The easiest way to save for retirement with no special filing requirements and a lot of flexibility in terms of investments. Roth IRAs also enable tax-free growth and tax-free withdrawals in retirement. The only drawback is that there are contribution limits and phase-outs at higher income levels.
  • Solo 401(k): A great option for those who want to save a lot of money for retirement during good years without necessarily committing to saving as much in bad years. The downside is that there’s a lot more paperwork involved than other types of accounts, which can make them more costly and time-consuming to administer.
  • SEP IRA: A good option for those that want to save a lot of money with a lower administrative burden than solo 401(k)s and no annual reporting to the IRS. It’s a good middle ground between an IRA and a solo 401(k).
  • SIMPLE IRA: A popular option that enables your business to contribute to your retirement savings (and deduct those matches). The downside is that these accounts can be expensive if you have a lot of employees, since there’s a company-matching requirement across the entire business.
  • Defined Benefit Plan: A potential option for wealthy self-employed individuals who want the security of a pension’s guaranteed payments. Of course, the drawback is that required contributions are very high.

The right choice depends on your specific circumstances. For example, gig workers may want to use traditional and Roth IRAs since they’re the simplest accounts, whereas high-earning self-employed individuals may want to consider a solo 401(k) to save more than IRAs allow. SIMPLE IRAs, on the other hand, are a good option if you have a few employees.

Since many self-employed people are self-insured, Health Savings Accounts, or HSAs, are another important type of account to consider. These are savings and investment accounts that are intended to help cover qualified medical expenses for high-deductible plans, but they can also be helpful for saving money in a tax-advantaged way beyond an IRA or 401(k).

Find a Strategy to Be Successful

There are many different investment strategies that you can use to save for retirement. While target date retirement funds provide an easy do-it-yourself option, financial advisors can help customize retirement plans to account for individual circumstances.

Robo-advisors have also found a middle ground in helping customize portfolios at a lower cost than a human advisor.

If you’re building your own portfolio, the single most important decision to make is choosing the right asset allocation. According to Vanguard, 88% of the volatility that you encounter and the returns that you earn can be traced back to asset allocation. Your experience will be very consistent with other diversified investors with the same asset allocation as you.

As you approach retirement, you will need to convert your investment portfolio into income by either selling assets, investing in income-generating assets, or oftentimes both. When it comes to income-generating assets, you can choose between conventional fixed income investments, dividend paying stocks or MLPs and other structures.

Don’t forget to explore our Portfolio Management channel to learn about different ways to rebalance your portfolio.

The Bottom Line

Nearly a third of Americans have at least some self-employment income while 14% of Americans rely exclusively on self-employment income. While self-employment has a lot of benefits, saving for retirement is one of the most significant challenges. The good news is that there are a lot of options designed to help the self-employed save in a tax-advantaged way.

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May 05, 2021