For people who make a living freelancing — working as an independent contractor — planning for retirement can look very different from someone who has an employer.
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While freelancers often have more freedom than the employed, they also may have fewer of the financial supports an employer offers, such as employer-sponsored retirement accounts and an HR department at the ready. And, since freelancers’ income may vary from month to month and year to year, it may be difficult to save steadily for retirement.
GOBankingRates spoke with two financial advisors, Ryan J. Janus, a CFP with Janus Financial, and Derek Mazzerella, a CFP with Gateway Financial Partners, to get their insights and tips. Keep reading to find out their 9 tips for freelancers planning retirement.
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Fill the First Cup
For freelancers who haven’t yet opened a retirement savings account because they aren’t making enough income to do so, Mazzerella recommends you do what he calls the “champagne tower.”
“Fill the first cup up. Get your emergency fund started, build up some excess cash flow since you have variable income and open a high yield savings account,” he suggested.
Start With an IRA or SEP
When you’re ready to open a retirement account, if your income is still low, consider starting with a regular IRA in which the limit is $16,000 per year. Your contributions and any growth the IRA makes are tax-deferred.
“If you don’t make a ton, a regular IRA makes sense,” Mazzerella said.
If you outgrow your simple IRA, consider a SEP (self-employed pension) IRA, which has a higher contribution limit — 25% of your income up to $69,000, and the interest is also tax deferred.
Consider a Roth IRA
If your income starts to become more significant, you might want to consider opening a Roth IRA, or doing a Roth conversion (rolling an existing IRA into a Roth), Mazzerella explained.
“Typically they’re better for younger folks — it grows tax free, and you take it out tax free,” he explained.
Additionally, a hidden benefit of a Roth IRA is that, if you make under a certain amount, “It’s not countable for your calculations for social security or medicare, so your social security may not be taxed.”
Consider a Solo 401K
Once your income becomes more robust, Mazzerella said it may be time to move up to a Solo 401(k) instead, which allows you to contribute even more than an IRA.
Janus added, another benefit of the Solo 401(k), should it be necessary, is that you can take a loan from this account and pay yourself back.
“Taking a loan from one isn’t always the best but when push comes to shove, it beats taking an early distribution,” Janus explained. “It will be less interest than a bank loan, and you don’t get a tax deduction for the interest that goes back into the plan.”
Automate Your Retirement Savings
Once you’ve figured out the type of retirement account you’ll use, Mazzerella said he’s a big fan of automating those savings.
“Most people tend to earn an income, spend money and save what’s left. You want to try and invert that. Set up savings goals first, a bucket of savings that automatically goes into [your retirement account] or any other savings bucket, then you’re free to spend what’s left.”
Don’t Wait Until End of Year
One mistake Mazzerella has seen freelancers do is wait until the end of the year to make a big lump sum payment into a retirement account.
“I think it is a mistake due to market timing. Either you’re missing out on [interest], or you might invest in a bad year.” It’s better to make smaller contributions across a year instead.
Maximize Your Tax Savings When Income Fluctuates
Because freelancers’ income varies often from year to year, to get the most out of your retirement savings Janus said it’s ideal to work with a tax professional who can help you determine the best vehicle for your money each year.
“I have clients who are retired but do consulting on the side. If they have a really big income year, we can make contributions into their self employed retirement plan and bring down their income,” Janus explained.
“If they have a low income year, we can do a Roth conversion to keep their tax brackets even, leading up to and through their retirement. Pulling those different levers goes a long way.”
A Roth conversion is where you take money already put into a tax qualified retirement account such as 401(k) or traditional IRA and move it over and just pay tax on the conversion in that tax year.
Janus continued, “If we have a married couple and in retirement, they expect their income will be less than 100K per year, right at 100K, they’d be the top of the 12% bracket, so if they have income that goes into the 24% bracket, I would like to defer it.”
Keep Cash On Hand
“Cash on hand is important when you’re self-employed, especially if you have a freelance role where you have variance in income,” Janus said.
“You want to be able to weather those down years without having to dip into retirement accounts or emergency funds.”
A lot of his clients use high-yield savings accounts for this purpose.
And while CDs can be great for generating interest, he warned that you still want to have liquid cash on hand.
Janus said, “I tend to avoid CDs because you may pay penalties for breaking those.”
Consider Your Tax Entity Status
Lastly, while many freelancers are registered as sole proprietorships, Janus explained that your tax entity selection could be important depending on the income level of the freelancer.
“So make sure that you’re regularly evaluating if staying a sole proprietorship is the best option. Are you maximizing your qualifying business deductions? Do you want to file as an S corp to cut back on self-employment taxes?”
Those questions and more, when reviewed with a tax professional, can make a difference when retirement rolls around.
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This article originally appeared on GOBankingRates.com: I’m a Financial Advisor: Here Are 9 Retirement Planning Tips for Freelancers