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Making a living
Retirement planning: Where to stash your cash?

There’s a crucial difference between retirement planning as a full-time employee vs. as a freelancer: The freelancer has to save significantly more.

Some employers match a portion of each dollar saved for retirement. A newspaper, for instance, might chip in 50 cents for every dollar saved, up to 6 percent of earnings. If you earn $50,000 a year as an employee, a benefit like that would net you an extra $1,500 a year in employer-provided savings.

Not impressed? Then consider this: The difference between a person who saves $3,000 a year for retirement and a person who saves $4,500 a year for retirement, assuming both people start saving at age 25 and each person earns an 8 percent annual return, is the difference between retiring as a millionaire or not. The person who saves $3,000 a year will have $872,000 at age 65, while the person who saves $4,500 a year will have $1.3 million at the same age.

Those may sound like large, comfortable figures, but consider that $1.3 million in 2050 won’t buy nearly what it can today, and probably won’t be enough for retirement.

The solution? Buckle down and start saving more now. If your self-employment as a freelancer is your main or only source of retirement savings, this is particularly important. You need to provide your best employee — yourself — with the benefits that employers traditionally offer.

Here are some tools and tips for saving more.

Start a SEP-IRA. SEPs, or Simplified Employee Pension plans, let self-employed people and small business owners sock away up to one-quarter of their net income, investing up to $53,000 in 2015 ($52,000 for 2014) of pretax dollars in an individual retirement account (IRA). In other words, it’s possible to invest now and not pay a penny in taxes until you withdraw the money. SEP-IRAs are popular with freelancers because they are easy to set up and generally have low annual maintenance fees.

Open a Solo 401(k). To mimic the 401(k) experience, self-employed individuals can open an Individual 401(k), also known as a Solo 401(k). “Employees” (that’s you) can make voluntary contributions of up to $18,000 per year, or $24,000 if they’re 50 or older, based on 2015 limits. “Employers” (that’s also you) can match a portion of these contributions. Like the SEP-IRA, these are generally easy and cost-efficient to establish and maintain.

One of the best benefits of a 401(k) is that you can either set up a “Traditional” plan (in which you defer income taxes this year but you pay the bill in retirement) or a “Roth” plan (in which you pay income taxes upfront, but don’t pay a dime in taxes during retirement — not even on the dividends or capital gains.) This could save you serious money down the road. Not all brokerages have the capability to set up Solo Roth 401(k) plans, but some — including Vanguard and Fidelity — can process these accounts.

Another advantage for some freelancers is that spouses can participate as well. But be warned: If you employ an assistant to whom you’re not married and who works for you for more than 1,000 hours per year, this plan is not for you. It’s only open to self-employed people with no employees other than a spouse.

Open a Roth IRA. These are retirement accounts in which you pay taxes today and then let the money grow tax-free until you withdraw it. When you take it out in 10, 20, 30 or 40 years, you’ll also withdraw it tax-free. This is a great vehicle for anyone who is in a low tax bracket, or anyone who anticipates paying a higher tax rate in the future than they are in now. Eligible individuals can contribute up to $5,500 a year to a Roth IRA, or $6,500 if you’re 50 or older (based on 2015 contribution limits). But beware: once your income reaches between $116,000 and $131,000 for individuals and $183,000 to $193,000 for married couples, you get phased out of eligibility.

Make catch-up contributions. Individuals over age 50 are allowed to save additional amounts in their retirement plans as “catch-up” contributions intended to boost their savings as they approach retirement. In 2015 these additional contributions can be up to $6,000 for Solo 401(k) and SEP-IRA plans. For Traditional and Roth IRAs, the catch-up contributions can be up to $1,000.

Investment basics

Once there’s cash in your retirement account, you know that cash should be invested, but you might not know anything about stocks and may be intimidated by the market volatility of the past few years. Don’t worry. All you need to understand is your age and your tolerance for risk.

Your age is simple, but most people can’t judge their own risk tolerance, often assuming they’ll be able to stomach more risk than is reasonable. When stocks are high, they’ll throw thousands into the markets and feel confident about their investing skills. When the markets crash, they’ll pull back and convince themselves that they haven’t chickened out; they’ve just “changed their minds” — then they walk away with half the money they originally had. They keep this remaining money in a savings account, miss the eventual stock rally and, in short, end up with the worst deal possible. All downside, no upside.

This is why honestly assessing your tolerance for risk is so important. Misjudging it can cost you thousands, so first, figure out your risk tolerance using this quiz. After that, follow two more steps:

Rule of thumb. Use this to figure out what percentage of your portfolio should be in bonds and what percentage should be in stock funds (such as index funds and commission-free exchange-traded funds).

The rule of thumb states that 110 minus your age is the percentage of your portfolio that should be in stock funds. For example, if you’re 30, then 80 percent of your portfolio should be in stock funds. If you have an appetite for risk, increase this number to 120 minus your age (so a 30-year-old invests 90 percent in stock index funds). If risk makes your stomach queasy, decrease this number to 100 minus your age.

Choose a scenario. Here is one possible risk-tolerance scenario for dividing your stock funds, but be sure to check with a financial advisor to determine a risk tolerance that works best for you:

High risk

• 40 percent domestic large-capitalization markets
• 20 percent domestic mid-cap and small-cap markets
• 30 percent foreign developed markets
• 10 percent foreign emerging markets

• 50 percent domestic large-cap funds
• 30 percent domestic mid-cap and small-cap funds
• 10 percent foreign developed markets
• 10 percent foreign emerging markets

• 60 percent domestic large-cap funds
• 15 percent domestic mid-cap funds
• 10 percent domestic small-cap funds
• 10 percent foreign developed markets
• 5 percent foreign emerging markets

Contributor: Paula Pant

Resources:

• Paula Pant’s website has more saving and investing tips.

Last updated: December 2016

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