The freelancer's guide to retirement savings accounts
Do you have enough saved for retirement for your age?
When you're employed at a company, the details of retirement are largely "set-and-forget" if you want them to be. Your 401(k) deduction is made before you even get your paycheck and you can rest easy knowing your check next month will come reliably. But as freelancers, it's our responsibility to provide a fruitful retirement for ourselves.
Fortunately, there are still options for the self-employed among us who want to get a head start on saving for tomorrow.
Roth IRA's are the secret sauce of retirement saving. With a Roth IRA, you can contribute up to $5,500 per year of after-tax ("take-home") money. But then, after age 59 1/2, you can make withdrawals from the account tax-free. This means that $10,000 invested in a Roth IRA will be $76,122.60 after 30 years of 7% growth, all available to you with no tax bill!
Want a great first small win on your way toward retirement savings excellence? Open a Roth IRA with Vanguard and contribute to the $5,500 limit each year.
Note that if your income exceeds $129,000 (if filing single), you are ineligible to contribute to a Roth IRA. Fortunately though, there exists a sneaky technique for converting a traditional IRA into a Roth called the Backdoor Roth IRA. Tax loopholes aren't just for corporate lobbyists anymore!
The traditional IRA is Roth's shy, modest cousin. With a traditional IRA, your tax incentives are swapped. You can contribute up to $5,500 per year, tax deductible in the year you contribute. But when you withdraw your funds after age 59 1/2, the gains will be subject to tax at your income tax rate.
The traditional IRA is a great choice if your income exceeds the $129,000 limit for a Roth IRA. It's also a good choice if you expect your retirement income to be lower than your current income. But if you're unsure and don't exceed the income limit for a Roth IRA, I'd stick with the Roth. It's likely the growth in your account will far exceed your contributions by the time you retire, so it's the more tax-advantaged choice.
The Solo 401(k), or i401(k), is the best way to minimize your taxable income. With the i401(k), you can make employee contributions of up to $18,000 per year, plus an additional employer match of up to 25% of your employee's salary, up to a maximum of $53,000 per year. Plus, you can contribute up to 100% of your employee's salary.
Additionally, some i401(k) plans have a Roth option, meaning you can make an employee contribution of up to $18,000 after-tax dollars per year and make retirement withdrawals tax free.
Because your i401(k) contributions are distinct from your Roth IRA contributions, this means you can contribute up to $23,500 per year into accounts that grow tax free. That's huge.
The biggest caveat with an i401(k) is that you cannot plan to hire employees into your business—the plan isn't permitted in businesses with common-law employees.
When I found out about the i401(k) plan, my jaw dropped to the floor. So this is how people get rich!
Health Savings Account
Wait, what? I thought we were saving for retirement? We are, but there's a secret weapon. The Health Savings Account (HSA) is a special type of savings account available to U.S. taxpayers enrolled in a high-deductible health plan (HDHP). Like a traditional IRA or 401(k), funds contributed to an HSA are not subject to federal income tax upon deposit. Funds can be withdrawn at any time to pay for qualified medical expenses without a tax hit. HSA's can typically be invested in similar mutual funds as in an IRA.
Like it or not, we're going to have medical bills. According to Fidelity Investments, a 65-year-old couple retiring this year will need $240,000 to cover their future medical expenses. By regularly contributing to an HSA, you can take control of your retirement medical care while saving money on your IRS bill.
Note that in order to qualify for an HSA, you must have a high-deductible health plan. These plans typically don't cover routine medical expenses or preventative care. You'll want to weigh whether it makes sense to step down to an HDHP to qualify, or if you're saving enough using other retirement vehicles.
What Should You Do?
Because you're a freelancer with no employees and you want to maximize your tax deferral, I recommend using a Solo 401(k) and a Roth IRA. These accounts will grow tax-free, are relatively easy to set up, and allow contributing $23,500 in total contributions if you're filing single.
To open these accounts now, visit Vanguard:
Want to Learn More?
I've been fine-tuning my freelance business to build wealth and become financially independent, and I want to help you do the same! That's why I've been writing a book called The Freelancer's Guide to Money---a one-stop guide to making your freelance business work for your future.
From corporate structures to saving for retirement to budgeting and beyond, making your money work for you can be a complicated process. I want to show you how easy it can be to get control of your freelance business's money so you'll have enough money to retire with dignity.