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Working for yourself brings a lot of excitement and opportunities. When work is fun, retirement might be the furthest thing from the minds of self-employed workers. But freelancers and small-business entrepreneurs shouldn't neglect saving for retirement, indeed, they must overcome certain financial obstacles to make sure they will be adequately protected for their golden years.
Freelancers (1) tend to lack a steady paycheck, which increases the need to keep more cash on-hand, (2) are ineligible to participate in most unemployment programs, (3) have no access to company-backed retirement plans, 401K matches, or pensions, and (4) have the desire to reinvest most of your earnings into the business. Or, you may have a corporate job but also make some money through some freelance consulting work. That is my situation. I wanted to minimize the taxes paid on my freelance work and save more towards retirement at the same time, so I looked into a few options available for workers with self-employment income.
Roth IRA
The Roth IRA is available to anyone with earned income, not just for the self-employed. But the Roth IRA may be an especially good choice for freelancers who are just starting out and can't yet make large contributions to their retirement or who have a need to preserve access to funds. The Roth IRA has a $5,000 limit for 2010 ($6,000 for anyone over the age of 55) and contributions can be withdrawn at anytime without penalty. This means that in a pinch, a Roth IRA can also serve as an emergency fund. For more information about a Roth IRA, please see here.
SIMPLE IRA
The SIMPLE IRA is suited for small-business owners who are planning to add employees and want to provide them with a retirement vehicle without incurring the time and expense of traditional 401K administration. For the employee portion of contributions, the limit for a SIMPLE IRA is $11,500 in 2010. Employers can chose from a set contribution of 2% of salary or a set match of 3% of salary. (Again, a freelancer may be treated as both an employer AND an employee, so in this case a freelancer may be able to contribute $11,500 plus 3% of pay).
SEP-IRA
The SEP-IRA may be the easier vehicle to set up. An employer (again, that's you) can contribute up to 25% of adjusted earned income to a SEP-IRA if you are incorporated, or 20% of income if you are a sole proprietorship, with a maximum contribution of $49,000 across defined contribution plans. This means that if you have a SEP IRA, a Roth IRA and a corporate 401K plan, the sum of all your contributions cannot exceed $49,000. The employee is not allowed to make any contribution to the SEP IRA. For example, if you make $15,000 a year in adjusted earned income on your side Etsy business, and you are a sole proprietorship, you will be able to put away $3,000 in your SEP-IRA.
Individual (or solo) 401K
The solo 401K is strictly for solo proprietors (the one exception is that spouses who are employed in the business are also eligible). This plan takes more time and money in the set-up process. For the entrepreneur who is making a significant amount of money, however, this option may be worth the additional hassle because the solo 401K such a high income deferral limit. As an employee, you can contribute $16,500 a year, as an employer, you can contribute another 25% of your pay, up to $49,000 a year.
Where can you open these accounts? Large mutual fund companies such as Fidelity, Vanguard, and Charles Schwab have special small business departments to help you in the process. Or, you can head to your nearest national bank, community bank, or credit union to sign up for a plan. Before you take the plunge, please have a tax professional review your situation to see what type of plan makes the most sense.
