Retirement Savings for the Self-Employed
Retirement Savings for the Self-Employed: Being self-employed can be incredibly satisfying. You get to be your own boss, keep your own hours, and make your own decisions about how to run your business. However, no matter what type of work you do, being self-employed still requires financial planning, and that means paying expenses, putting enough money aside for taxes, and preparing for retirement.
McKinsey estimates that there are 68 million freelance workers in the United States. Many entrepreneurs are taking advantage of the gig economy, taking contract jobs doing everything from driving for Uber and Lyft to professional consulting work. However, if you are working as a contractor, you are not entitled to benefits such as a company-sponsored 401(k) savings plan. This makes it even more essential to set aside money for income taxes and other expenses.
Unfortunately, data tells us that entrepreneurs aren’t great at retirement planning. A survey of 1,960 small business owners revealed that 34 percent lack a retirement savings plan. The reasons these entrepreneurs cite for not saving for retirement include lack of income (37 percent), a need to invest their savings to fund their business (21 percent), and planning to sell their business to pay for retirement (18 percent).
The good news is that as a self-employed worker, you have a variety of great retirement options available to you. Here’s how you can make the most of your retirement options.
Plan Ahead for Taxes and Retirement Funds
The biggest mistake that most self-employed people make is not saving enough for annual contributions. Every payment that comes in is seen as profit, especially if you have a low-overhead business such as consulting. You set your own salary and pay yourself from whatever you earn. However, you need to be sure to set aside enough from each payment to account for federal and state income taxes, self-employment taxes, and retirement funds.
When you are self-employed, your income tends to change from year to year, so you have to accurately predict your annual earnings to prevent a shortfall come tax time. Most self-employed workers make quarterly estimated tax payments (1040-ES) to cover federal income taxes. In addition to income tax, you will need to calculate self-employment tax, which includes 12.4 percent for social security and 2.0 percent for Medicare.
Setting aside enough cash for taxes is one thing, but what about financial planning for retirement? You can save a substantial amount on taxes with a tax-deferred retirement account, but the amount you can put into retirement savings is dictated by your earnings, and you usually can’t make an exact determination until tax time.
Your best strategy is to set aside a portion of every payment for taxes and retirement. Depending on your earnings, you may want to plan to set aside anywhere from 25-33 percent.
Financial Planning Is Essential
If you are working for yourself or considering self-employment, develop a financial plan in advance.
Make sure your plan includes doing the following:
Establishing a savings account or money market account where you can put aside money for taxes and retirement savings.
Making your quarterly tax payments based on projected income.
Saving enough to contribute to a tax-deferred retirement plan. If you fail to save enough it could mean a bigger bill come tax time.
Talk to your financial advisor about opening an IRA, SEP IRA, Simple IRA, or other retirement account, and be sure to transfer money into those accounts at least once a year. The more you can contribute to your retirement accounts, the faster your retirement savings will grow, and the more you will save on your taxes.