Winter is Coming: How to Brace for Freelance Cold Periods
The freelance lifestyle is an attractive one. But with all of the flexibility comes the reality that work might not always be as regular as we
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One of the hardest habits for new freelancers to form is saving. Independent workers are on the hook for self-employment tax, and they also need to stash 30 percent of each paycheck away for taxes. Further on the horizon, they also need to build their retirement savings.
Shifting from the 9-to-5 means that you lose the safety net afforded by a full-time employer, but fear not: Just as you approach your work with an independent and entrepreneurial mindset, you can do the same for your business and your personal finances..
Since independent workers don’t have the benefit of a company-sponsored 401K or employee matching, it can be easy to let savings slip. This article will provide basic best practices for getting started.
Having a retirement savings account is important and many people do not realize the power of compounding interest until it’s too late. In the midst of the excitement of transitioning from fulltime to freelance, it can be easy to de-prioritize retirement savings, but doing so can have dramatic effects on your quality of life down the road.
Compound interest occurs when the interest that adds to an amount of money, in turn, adds interest itself. Over time, if you start early enough, your savings will snowball. This graph compares the difference between simple and compound interest. The longer you wait to start saving for retirement, the smaller the benefit you receive will be in the future.
The best thing you can do for yourself is to make a plan and establish yearly retirement savings goal. Most expert suggest devoting a significant portion of your income, such as 10 to 15 percent, to meet your end goal. You can use this tool to judge how much you should be saving or how on track you are to meeting your goal.
The easiest way to hold yourself accountable is to set up automatic withdrawals. Keep in mind that things like late payments can throw this off, so you need to ensure you have a cushion in your account. Going back to the idea of compound interest, it’s always better to start saving small amounts now than wait. If you can’t make the 10 percent since your income is cyclical, don’t fret! Look around for a retirement savings plan that allows you to make payments when you can.
Traditional and Roth IRAs
To help you throughout the process, you can open up an Individual Retirement Arrangement (IRA) or a Roth IRA account where you contribute up to $5,500, or $6,500 if you’re 50 or older. Traditional IRAs are a better option if you are eligible for the tax deduction now, or expect to be in a lower tax bracket in retirement. However for many, Roth IRAs are advantageous since you will pay taxes on your contributions now and will not be taxed on any earnings when you withdraw the money in retirement.
A Roth IRA can also serve as an emergency account because you will not be penalized for withdrawing your contributions since you have already paid taxes on them. With a traditional IRA, you’d be paying taxes on your withdrawals later, but getting a break from paying taxes on them now. Though the Roth IRA seems enticing, you are only eligible to contribute up to $5,500 if your modified adjusted gross income (MAGI) is $114,000 or less. If your MAGI is $129,000 or more, you cannot contribute to a Roth.
The same applies those who file joint, except the bracket is anything less than $181,000 can contribute the full amount, anything more than $191,000 cannot, and anything in between can contribute a reduced amount.
If you want to contribute more than the $5,500, you can take the extra money you have and save more in a solo 401K or simplified employee pension plan (SEP IRA). A SEP IRA is a retirement savings account for small employers to help employees set aside money for retirement. If you set up a SEP IRA with a Roth IRA, you can avoid paying taxes on your SEP since you’ll pay taxes on your Roth.
A solo 401K allows you to take out loans on the money and save more than the SEP. Also known as a solo-k, the account has a feature known as “catch-up contribution” that allows you to contribute up to $23,000 a year toward retirement instead of $17,500 (if you 50 or older). The solo-k also has profit sharing, which lets you contribute $17,500 from your wages or 25 percent of the profits of your business (20 percent if you are a part of an LLC).
This may seem like a lot right now, but talk to an accountant and value all your retirement saving options. It is important to choose the plan that best suits your needs with your current freelance position.
Once you’ve made the decision to save, it’s time to determine where your money will grow the most. There are a couple of options.
How aggressive you decide to invest depends on your goals. If you’re relatively young, retirement is a long-term strategy, therefore you might be more apt to take on higher risk since you have more time to bounce back from market fluctuations. Still, the mix is up to you. Most experts will advise against getting a money manager. A money manager is someone who helps clients look at their investments and suggest how to grow those funds. Even if a money manager helps you invest in a high-performing portfolio, the net benefit to you is diminished since you are taking on the cost of a manager.
Index funds allow you to ride trends across sectors of the market without the need for a money manager, which will take a cut of your profits. Based on the S&P 500, an index fund will never outperform the market. Both the fund and the S&P will be the same. Because of consistency between the two, index funds don’t need a money manager. In fact, indexes outperform managers 92 percent of the time. Cutting out the money manager means more money in your pocket come retirement.
According to a recent study, 40 percent of freelancers are neglecting to contribute to their retirement savings plan. The longer you wait, the less attractive your compound interest ending balance will look. The reality is, actively saving for retirement can be a fulfilling exercise once you navigate the basics of investment, not to mention it’s one of the most responsible things you can do for yourself as a self-employed professional.
It’s a lot to take in, and it can be hard—intimidating even—to put part of your paycheck towards the unknown future. However, as long as you have a plan and make a regimented amount of contributions, you’ll be much better off when it comes time for your retirement.
Note: The author of this article is not a wealth management expert. We recommend using this primer as a starting point to your research.
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