In the initial throes of setting up a freelancing business, saving for retirement may be the last thing on your mind. However, if you let it sit on the back burner, you’d be making a very big mistake. Retirement savings are essential if you want to avoid working very late in life on things you don’t want to work on just to stay alive. They’re also essential if you want to leave something behind for your loved ones or avoid poverty in your late years. Add in the fact that most people are living longer and retirement becomes a huge concern.
We know how important saving for retirement is, but humans have a big blind spot about problems that are way off in the future. When you’re young and retirement is 40-50 years away, it seems that there’s all the time in the world to save for retirement. And besides, isn’t covering other essentials and saving up for that vacation more important now?
We believe saving for retirement is an essential, and here’s why.
Compound Interest for Freelancers
Saving for retirement all boils down to taking advantage of compound interest. By taking a very small nest egg and putting into a retirement account for decades, you can grow quite a sum of money that you can then use to retire. Let’s take a simple example of compound interest to show how this works.
Let’s say you put $100 into an account that pays 10% interest per year (keeps the math simple.) After a year in the account, that $100 will earn $10 (10% of 100), for a total of $110.
The next year, the interest increases to $11 (10% of 110), and the next to $12.10 (10% of $121).
After ten years, the account will be at $259.37, more than double the initial deposit. After twenty, $672.75.
And if you were smart and invested just $100 in this account at age 25 and left it till age 65, you’d have an ending balance of $4,525.93!
Think you can’t afford to slip in $100 a month into a retirement account now? The earlier you start saving, the more your money has a chance to grow. It doesn’t take much to net a tidy sum and most people don’t make just one deposit. They make deposits month after month. If you put in $100 a month into your 10% account every month for 40 years ($48,000), you’d have $584,222.17 at retirement! Even if was just a 5% return, you’d still make $292,111.09.
It’s very instructive to play around with a compound interest calculator and see how much you can earn over time. You can find one at MoneyChimp and many other places on the web. The point is that the earlier you start socking away money, even if it’s just $50 when you can, you will get a significant jump start on your retirement that starting late.
Too Late to Save? Incorrect, My Freelance Friend
But what if you did start late? This is the other big excuse you’ll hear from both freelancers and even employees. They might think they missed their big compound interest window and now it’s not worth the hassle. This is another huge mistake.
Any retirement saving is better than no retirement saving. There are things you can do later in life like delay your retirement date to give you more time on your accounts. A good financial advisor can also help you maximize the time that you have so you can get the most return on your money.
Also, older people often have an advantage over their younger counterparts. They know what their true expenses are and aren’t spending as much on frivolous things. Tightening the belt now for a comfortable retirement later isn’t necessarily seen as a bad thing.
One of the problems specific to freelancers and other self-employed people is managing their retirement accounts. When you work for an employer, they handle most of the plan for you. At most, you might select the specific blend of investments or even choose individual funds for your accounts, but everything else is handled by the employer. As a freelancer, it’s all on you to set up the accounts and maintain them, but you get a bonus. Self-employed people can deposit more money into most retirement accounts yearly than employees. Plus, you get access to the same retirement plans.
Understanding the different retirement plans isn’t hard, but it does require study. The basic procedure is this. First, you deposit money into a retirement account where it earns interest. After retirement, which usually has to be after age 59 ½, you can withdraw the money. That’s when you’ll have to pay taxes, but because you’re earning less your overall tax burden should be lower.
With these basics in mind, here are some different types of retirement plans that work best for freelancers:
IRA (Individual Retirement Arrangement)
An IRA is a method for saving for retirement when you don’t have access to an employer 401(k) plan. You can save up to $5000 per year, plus an extra $1000 per year if you’re over 50. The withdrawal date is at 59 ½. Note that your contributions may be tax-deductible! Speak with one of the AND CO advisors for further information on this important point.
A Roth IRA is like a traditional IRA, but you pay taxes on your deposits first. That way, when you withdraw you won’t have to pay taxes at all. The deposit maximums are largely the same unless you have a lot of income or you also have a traditional IRA. You will also need to start the account before you reach age 54 ½ to avoid possible penalties. If you make a lot of money and can afford the extra taxes, a Roth IRA can help you reduce taxes later in life.
SEP (Simplified Employee Pension Plan) IRA
You can contribute a lot more per year to a SEP IRA than a traditional IRA, but the amount varies depending on how much you earn. The top maximum is $50,000. SEP IRA contributions are tax-deductible. All else is the same. Speak with an accountant to find out what your maximum contribution might be or consult IRS publication 560.
SIMPLE (Savings Incentive Match Plan for Employees) IRA
This plan was designed for an employer and employees, but you can set one up for yourself. The SIMPLE gives you a limit of $11,500 per year, plus an additional $2,500 if you’re age 50 or older. If you ever plan on hiring employees, it will be easy to add them to your plan but you will need to pay 3% on their contributions.
Two other retirement plans you may want to look at are the solo 401(k) plan and the Keogh plan. These plans let you save much more than an IRA, but they are much more complex and have higher fees than IRAs. If you are making enough that you’re nearing your maximum contributions on your IRAs, speak with an accountant about whether these plans might be a good addition to your retirement portfolio.
In fact, before opening any retirement account you will want to speak with an accountant. your contribution limits might change depending on whether you or your spouse have additional retirement plans. Plus, you’ll need to know what documentation you’ll need to keep for your taxes.
Opening an IRA account of any type is pretty straightforward. Most banks will let you do it for a small minimum deposit and a bit of paperwork.
There’s no excuse for not saving for retirement. Even setting just $50 a month now can get you peace of mind for your retirement years. Speak with your AND CO about what retirement plan may be best for you. Don’t let the freedom of your freelancing years blind you to what you need to do to have a comfortable retirement.