Saving for Retirement as a Freelancer

By Hightower Westchester on June 5, 2023

As more and more workers take advantage of the gig economy and work as freelancers, we wanted to address the challenges of saving money for retirement in these roles.

Freelance workers often have difficulty saving for retirement due to the lack of an employer-sponsored retirement plan. Without proper guidance and a proper setup, freelance workers can put themselves behind the eight ball.

With variable incomes, choosing the appropriate retirement plan becomes even more important. Below is a list of retirement accounts that may fit your needs.

SEP IRA – Simplified Employee Pension

A SEP IRA (Simplified Employee Pension) is an easy-to-administer retirement plan for anyone who is self-employed, owns a business, employs others, or earns freelance income. This retirement plan is often referred to as a profit-sharing contribution.

Employers are typically the sole contributors to a SEP IRA, but employees may be able to make traditional IRA contributions to the SEP IRA.

One can contribute up to 25% of the employee’s total compensation or a maximum of $66,000 for the 2023 tax year, whichever is less.¹ Contributions must be the same for employers and employees up to the specified limit. Much like other retirement accounts, earnings grow tax-deferred, and contributions are tax-deductible.

Unlike other plans, employees can’t defer their salary to make contributions to a SEP IRA. They may be able to make traditional IRA contributions to the SEP IRA of up to $6,500 ($7,500 for employees age 50 or older) for the 2023 tax year.

A SEP IRA offers a lot of flexibility, as you can contribute different amounts every year or nothing at all. It’s important to note that, like traditional IRAs and 401(k)s, participants age 72 or over must take required minimum distributions (RMDs) from a SEP IRA.

Solo 401(k)

A Solo 401(k) plan, also known as a one-participant 401(k) or a Solo-k, offers self-employed people an efficient way to save for retirement. There are no age or income restrictions, but participants must be business owners with no employees (apart from spouses). In fact, with a spouse in the plan, your small business can really stash away cash for retirement. A qualifying couple could save as much as $132,000 annually in the plan, and even more if they are eligible for catch-up contributions.

One key difference between the Solo 401(k) and other self-employed retirement plans is that employees can contribute all their salary up to the annual maximum contribution. The big benefit of the Solo 401(k) over other plans for the self-employed is that you can make big pre-tax contributions at lower income levels because of the employee contribution, which can equal up to 100% of your earnings up to $22,500 in 2023, or up to $30,000 if you’re 50 or older (you’re not limited to the 25% of earnings of a SEP IRA). Though this contribution doesn’t help you avoid the self-employment tax.

As an employee, you can contribute up to $22,500 in 2023, or up to $30,000 if you’re 50 or older. In addition to this, you can contribute 25% of your self-employment income or compensation as an employer contribution — up to an overall maximum of $66,000 (or $73,500 for those over 50).

In other respects, the Solo 401(k) operates like any other 401(k) plan, whether it’s a traditional 401(k) or a Roth 401(k). If you set up your Solo 401(k) to take tax-deductible contributions, it will operate like a traditional 401(k), allowing you to contribute pre-tax money and get a break on this year’s taxes. On the other hand, if you opt for a Roth, you’ll make after-tax contributions, but will benefit from tax-free withdrawals in retirement. This Roth option can be an advantage over SEP and Simple IRAs.

Simple IRA – Savings Incentive Match Plan for Employees

A Simple IRA is a retirement plan that allows employers and employees of small businesses to make tax-deferred contributions to a retirement plan. Simple IRAs are best for self-employed individuals or small business owners with 100 or fewer employees.

To be eligible, employees must have earned at least $5,000 from the employer in any two preceding years and expect to receive at least $5,000 during the current year.²

Both employees and employers can contribute to this plan. However, employers are required to contribute either a matching contribution of up to 3% of compensation (matching meaning, the employee must contribute to get it) or 2% of all eligible employees’ compensation, regardless of whether they contribute.

• Option 1:  Dollar-for-dollar match of employee contributions up to 3% of each employee’s compensation (which can be reduced to as low as 1%, but the reduction can only be in place for two out of five years.)²
• Option 2:  A contribution of 2% of each employee’s compensation. The maximum compensation used to determine this contribution is $330,000 for 2023.²

Contributions are tax-deductible and are required every year. Employees can contribute up to 100% of their compensation in 2023, up to a maximum of $15,500 or $19,000 if they are 50 or older.²

Like other retirement accounts, early withdrawals are subject to a 10% penalty if you are under the age of 59 ½, but if you withdraw within the first two years of your plan participation, you’ll incur a 25% penalty instead. Your investments grow tax deferred until you make a withdrawal, and employer contributions are tax deductible as business expenses.

IRA – Traditional or Roth

An IRA is perhaps one of the easiest ways for self-employed people to start saving for retirement. There are no special filing requirements, and you can use it whether or not you have employees. There are two basic types of IRAs, the traditional (pre-tax) IRA and the Roth (after-tax) IRA.

What differentiates the two is the timing of paying income tax on the money you contribute. If you opt for a traditional IRA, you will pay taxes when you withdraw the money in retirement. If you go with a Roth IRA, you will pay taxes upon contribution but have no taxes when you’re withdrawing money.

The IRA contribution limit for 2023 is $6,500, or $7,500 if you are age 50 or older.

If you can afford it, in addition to one of the above-listed options, you should consider contributing funds to an IRA as well.

Self-Employed Defined Benefit Plans (SE-DBP)

A Self-Employed Defined Benefit Plan is usually best for a self-employed person or business owner with no employees who has a high income and wants to save a lot for retirement on an ongoing basis. This type of plan provides a predetermined retirement benefit based on a formula that considers your age, salary, and years of service.

Contributions are tax-deductible, and there are no contribution limits; however, there are limits to the final benefit payment at retirement. In 2023, the maximum annual benefit could be up to $265,000.¹ These plans require professional help to set up a plan design.

So, all that being said, how do you save money for retirement? Well, as we have listed in countless blogs before, track your spending, automate your savings, and take the time to set up a plan! We all know running a business takes up a lot of your time, but it is important to set up a retirement plan for your future. Engaging a professional advisor or accountant when opening these accounts is advisable.

If you have any further questions on how to set these up and/or want to talk about what is most fitting for you and your situation, please feel free to reach out.

Richard Flahive –Chief Investment Officer – Hightower Westchester

914.825.8639 – rflahive@hightoweradvisors.com

¹https://www.irs.gov/retirement-plans/retirement-plans-for-self-employed-people#:~:text=You%20can%20put%20all%20your,contribution%20or%20a%203%25%20matching

²https://www.irs.gov/retirement-plans/plan-sponsor/simple-ira-plan