5 Ways The Self-Employed Can Invest for Retirement

When it comes to being self-employed, it can feel like the deck is stacked against you. 

Gig workers and independent contractors don’t have the benefit of an employer-sponsored 401k plan or retirement contribution matching program. It can be tough to set aside 15-20% of your income to pay your own payroll and Social Security taxes, take out a little bit more for your healthcare program, and then worry about retirement savings on top of that. 

Still, here are 5 ways the self-employed can invest for retirement.

Why Worry About Retirement At All?

The outlook for retirement in the United States is bleak, to say the least. If you aren’t worried about it, you should be.

Here are the facts:

In the United States, 15% of adults aged 25+ have nothing saved for retirement at all, according to Northwestern Mutual’s Planning and Progress Study.

For those that do have retirement savings, the median 401k account balance is only $25.8k (roughly $64.5k for adults at retirement age), according to Vanguard’s 2020 Analysis, “How America Saves.”

But there’s always Social Security, right? Unfortunately, if that’s what you’re relying upon, you’ll only be slightly above the poverty line during your Golden Years. The average Social Security benefit is about $18k per year, according to the Social Security Administration.

Meanwhile, a retiree’s average expenditures are $49,279, according to the Bureau of Labor Statistics.

That means, of the 85% who do have retirement savings, only a very small fraction of them can actually afford to retire.

Luckily, if you clicked on this article, we’ll get you set on the right path. And, if you’re young, your money has time to compound, which means even a little bit of money goes a long way.

self-employed retirement strategies: playing cards Self-Employed Retirement Investing Strategies

Roth IRA

The Roth IRA is the gold standard for most self-employed people, for both its effectiveness and ease of use. Why? First off, when you open a Roth IRA, you contribute after-tax money. Normally, with a 401k or traditional IRA, your money grows tax-deferred, so it lowers your tax bill for the year by reducing the amount of taxable income that you have, and then you pay normal income taxes on distributions that you take in retirement.

With a Roth IRA, you’re paying those taxes up-front and, in return, receiving tax-free distributions in retirement. According to the Congressional Budget Office, taxes are near historic all-time lows. We can’t predict the future and we aren’t trying to, but there’s a solid chance that taxes won’t remain as low as they currently are. It’s certainly possible that they remain at the same rate, or possibly even decrease — but, looking at historic trends, it seems unlikely. 

If you expect a similar income in retirement as you have now — or if, after your ~$18k per year Social Security benefit, you expect to make more, or if you expect taxes to increase — then the Roth is your go-to.

Furthermore, a Roth IRA is simply easier than a 401k. In order to open a 401k, you need an EIN at the very least, but if you want to open a Roth IRA, you just have to contact an investment firm and request one. You could do it online in fifteen minutes.

Finally, you can withdraw your contributions penalty-free at any time. You don’t have to wait until you’re 59 ½, like you do with a lot of other accounts (although you will be taxed on gains that you withdrew). So, if you put in $5k last year, and that $5k grew to $8k, you can still withdraw up to $5k with no penalties, because you already paid the taxes on it.

What’s the catch?

  • If you’re under the age of 50, you can only contribute $6,000 to a Roth IRA per year. If you’re above the age of 50, that number increases to $7,000.
  • For the tax year of 2021, the income limit for Roth IRA contributions was $140,000 for single filers and $208,000 for a married couple filing jointly. If your maximum adjusted gross income was more than that, you can’t contribute to a Roth IRA.

Solo 401k (Roth or Traditional)

The Roth 401k takes the second spot on our list, tied with the traditional (although we’ll explain why we prefer the Roth).

A 401k is a bit more difficult to open than an IRA. In order to open a solo 401k, you must be a business owner with no employees, and you must have an employer identification number (which you can quickly get by applying for one with the IRS).

The benefits of the Roth 401k are similar to the benefits associated with a Roth IRA, except the contribution limits are much higher. You can contribute up to $57,000 to a Solo 401k, so chances are you’ll never truly max out your retirement savings — although major props to you if you do.

If you invest in a Roth 401k, you have access to your contributions at any time, which gives you quite a bit more freedom regarding when you use your money.

But, with that said, the traditional Solo 401k is also a great option. Plus, if you combine it with the Roth 401k, you’ll have more options in retirement for controlling your taxable income to make sure you stay below a certain tax bracket.

Traditional IRA

The traditional IRA is similar to the Roth except it works the other way: you pay taxes in retirement rather than now.

A traditional IRA is your best option if you expect your income in retirement to be lower than it is right now, if you earn too much to contribute to a Roth, or if you expect tax rates to decrease.

This might seem confusing. You might be thinking to yourself, “Now I have to gamble on whether or not taxes are going to go up? I don’t know anything about that. This is all too much. I don’t want to think about it right now.” Rest assured that the difference between a Traditional IRA and a Roth IRA is not a deal-breaker. The deal-breaker is inaction, doing nothing at all, continuing not to contribute to your retirement. Very few people look back and say “I wish I had saved less for retirement,” but at our current rate, about 90% of people are going to wish they had saved more — chances are, you’re one of those people.

Here are some things to know about the Traditional IRA.

  • The contribution limits are the same as the Roth IRA, listed above.
  • As for the income limits, the traditional IRA doesn’t have any. However, for single-filers, deductions begin to phase out at $66,000 and phases out entirely at $76,000,

Simple IRA

The Simple IRA is a good option if you’re looking to hire employees in the future (or if you currently have employees). Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, any business that sets up an automatic contribution plan for retirement gets a $500 tax credit.

The Simple IRA contribution limits are $13,500. You’ll have two options for your employees: automatically contribute 2% of their paycheck or match 3% of their contributions dollar-for-dollar. The option you choose depends on how much they currently earn and how much you’re willing to contribute.

SEP IRA

The maximum contributions for a SEP IRA are 25% of your earnings up to $57,000.

SEP IRAs offer fewer benefits than the Roth IRA or Solo 401k, and you can’t make catch-up contributions past the age of 50. Still, SEP IRAs are easy to set up and typically have low administrative costs. They were designed for businesses that wouldn’t have otherwise developed a retirement plan.

The exact limitations are a bit more confusing, and they depend on how many employees you have — that’s why it earns the bottom spot on our list.

Conclusion

Gig workers and independent contractors have a lot to juggle. You have to pay close attention to your taxes, making sure you’re setting aside at least 15-20% for payroll and Social Security taxes. After that, you have to consider how you’re going to pay for healthcare. Then, finally, you get to worry about your normal tax bill.

Amidst all that, while you’re just trying to get a business off the ground or do some gig work on the side, it can feel like it’s impossible to plan for retirement. 

With these 5 ways the self-employed can invest for retirement, though, we’ll get you set on the right path to a well-funded retirement. 

 

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