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Freelancers face a lot of challenges: Filing taxes every quarter, sending out invoices, avoiding distractions at home, and working hard to cover next month's rent. Though cash flow can be unpredictable (financial instability often comes with the freelance lifestyle), setting money aside for retirement is still a must—since there's no employer to set you up automatically.
You’ve probably heard of Individual Retirement Accounts (IRAs) and Roth IRAs. Another option, especially for freelancers or business owners with employees, is a Simplified Employee Pension (SEP-IRA).
As CNN Money notes, 'A SEP IRA could be the perfect choice if you’re running a solo operation and intend to keep it that way.' You can open one at nearly any bank, brokerage, or mutual-fund company, with few or no annual fees.
The main advantage of an SEP IRA over traditional IRAs or Roth IRAs is the higher contribution limit: You can contribute 25% of your income, or up to $55,000 for 2018, whichever is less. Compare that to the $5,500 limit for IRAs ($6,500 for those over 50) and the 401(k) limit of $18,500 ($24,500 for those over 50).
Like a traditional IRA, the money in a SEP-IRA is taxed when you withdraw it. While there are no catch-up contributions, the higher contribution limit makes this less of an issue. Plus, if you're having a rough year, you can contribute less (or nothing) and increase your contributions when you’re doing better financially.
If you save regularly, you’re likely to accumulate more for retirement in a SEP-IRA than you would in a traditional IRA. This graphic from Wealthfront illustrates the potential (Note: it assumes IRA contributions remain at $5,500, though they will increase, and expects a 7% annual rate of return):
The only tricky part is deducting your contributions. According to Wealthfront:
Simply put, your annual SEP plan contributions cannot be deducted by more than 20% of your net earnings from the business (this is separate from the 25% of your total income minus self-employment tax mentioned when we discussed contribution limits earlier). For someone with net earnings of $200,000 and a self-employment tax of $9,728, the maximum deductible contribution would be $14,841.
This is something you may want to discuss with a financial adviser.
Despite the minor tax complexities, the potential benefits make it worthwhile. For more on other retirement account options tailored for freelancers, such as Solo 401(k)s, check out this article.
