Retirement Fund Options for Freelancers and Others

I must tell you, over the years I have seen a lot of changes to the way Americans plan for retirement. Nowhere is that more evident than with my new buddy, Alex, who I got talking to at the softball field last week while watching Maeve and Phoebe who play for Falmouth High help defeat Martha’s Vineyard. Alex is an excellent example of the “new economy” – for better and for worse.

Alex is in his late 40s, married, with a pair of young teenagers. His career in advertising sales seemed quite stable until the company he worked for shut its doors last year. He pounded the pavement looking for a new gig but came up short and eventually realized he was on his own. For the past six months or so he’s been working as a freelancer. The checks are coming in, and Alex is righting his ship. But ever since the layoff, he’s had his retirement savings plan on hold. And now that he’s working for himself, he’s on his own when it comes to planning for his retirement.

Alex isn’t alone. As I said, we’ve seen a lot of changes in how people save for retirement. That transition kicked into high gear in the early 1980s, when companies began to shift away from funding defined benefit plans, which guarantee loyal employees a payout upon retirement – the traditional pension plan. Instead, companies began offering defined contribution plans – the venerable 401(k), which shifts the burden to the employees to contribute their own money if they want to see a match from their employer. With a defined contribution plan, the amount the employer contributes is guaranteed (if eligibility requirements are met), not the amount that will be paid out at retirement.

In the wake of the Financial Crisis of 2008, we saw something else happen: Companies once again started hiring, but fewer and fewer of them offer full-time jobs and/or full-time benefits for their employees. Now, more than one-third of full-time employees lack access to a workplace retirement plan, according to a recent survey by the Pew Charitable Trusts.

You see, it’s very common these days to talk with folks who are juggling two, sometimes three part-time jobs to help make ends meet, none of which offer retirement benefits. In fact, more of us than ever before fall into that “freelance” category, like Alex, and that’s a trend that will continue. A 2017 study published by UpWork and Freelancers Union predicts that by 2027, freelancers will make up most of the American workforce.

Given that freelancing and self-employment are the new norms for many of us, we need to update our thinking about retirement. Since we can’t rely on workplace benefits to provide a vehicle for our retirement savings, that means taking things into our own hands.

If you work for a company that does not offer an employer-sponsored plan, or if you’re not eligible to take advantage of a workplace plan, an Individual Retirement Account (IRA) is a good option. In fact, IRAs can be an excellent supplemental option even for those folks who are eligible for an employer-sponsored plan.

Traditional and Roth IRAs allow you to contribute up to $5,500 per year in total ($6,500 if you’re 50 or older). With a traditional IRA, if you are not a participant in an employer-sponsored plan, you can deduct your contributions on your tax return. If you are a participant in an employer-sponsored plan, you may still be able to deduct your contributions if your Modified Adjusted Gross Income is below certain limits. However, when you take distributions from a Traditional IRA, all funds withdrawn are subject to ordinary income tax. Contributions to Roth IRAs aren’t tax-deductible, but you can withdraw the money in retirement tax-free (provided you are over 59 1/2 years old and your first Roth IRA contribution was made at least five years earlier).

One rule of thumb to consider when deciding what IRA is more appropriate for you: If you expect to be taxed higher in retirement than you are now, a Roth may make sense. If your goal is to lower your taxes now, a traditional IRA could help to do that. Whatever you do, always consult a qualified retirement specialist that will help teach you the questions you need to ask yourself so you can make the best financial decision for you.

Alex is in a different boat. He’s self-employed. One option is for Alex to open an Individual 401(k), also known as a Solo 401(k). An Individual 401(k) will allow Alex to contribute up to $18,500 annually, plus additional money of up to 25% of his compensation (not to exceed $55,000). Once he turns 50, the annual contribution limit bumps up to $24,500, with a $6,000 catchup provision, raising the limit to $61,000.

A SEP IRA is another option for self-employed folks. Contributions are tax-deductible but limited to no more than 25% of compensation with a maximum annual contribution limit of $55,000. Unlike Individual 401(k)s, SEP IRAs are also an option for businesses with employees.

A SEP IRA can be easier to set up than an Individual 401(k), but there’s no provision for catch-up contributions and all contributions are made by the employer, not the employee. There’s no provision to take a loan from a SEP IRA either. Also, contributions must be made for all eligible employees. So, if Alex hires employees next year, he’d be required to contribute to their SEP IRA at a salary percentage equal to what he’s contributing to his own fund.

Alex put his retirement savings plan on hold after he found himself without work. He left the 401(k) money from his previous employer untouched since his employment ended. It’s been growing, but he hasn’t been able to make any additional contributions. And considering the recent volatility in the markets, he has missed out on what some consider a “buying opportunity.” But now that Alex’s financial situation is improving, Alex is anxious to get a retirement savings plan going again.

Alex and I talked about his options and he decided the most appropriate one for him is to open an Individual 401(k). Alex will be able to deduct those contributions. And because the Individual 401(k) is an IRS-approved Qualified Retirement Plan, he can roll over the balance from his previous employer’s plan without incurring a tax penalty.

With planning, perseverance, and persistence, Alex’s new freelance business will continue to grow and his retirement investments will too.

Be vigilant and stay alert, because you deserve more.

Have a great week!

Jeff Cutter, CPA/PFS is President at Cutter Financial Group, LLC. A wealth management firm with offices is Falmouth, Duxbury, and Mansfield. Jeff can be reached at jeff@cutterfinancialgroup.com.

Cutter Financial Group LLC (“Cutter Financial”) is a SEC Registered Investment Advisor.

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