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6 Retirement Planning Challenges for Freelancers & Entrepreneurs

There are more self-employed Americans now than ever before. One Gallup survey found that 36% of American workers participate in the gig economy — and that was before the pandemic reshuffled the workforce.

These workers face unique retirement challenges. As they struggle to make ends meet without employer benefits, retirement can seem awfully far away, while demands like saving for a down payment on a house, paying rent, and buying a car all feel tangible and immediate.

The problem is that by the time retirement starts feeling like a looming reality, it’s exponentially harder to prepare for it. Here are six unique challenges that self-employed Americans face, along with tips for mitigating them and getting back on track for retirement as a freelancer or small-business owner.

Challenge 1: No Employer Retirement Benefits or Plan

One of the perks of a full-time job is a company 401(k) retirement plan, possibly with matching contributions. Better yet is a defined-benefit pension. These still exist, even if they’re less common than they used to be.

With an employer-sponsored 401(k), employees under age 50 can contribute up to $19,500 per year in 2021. That’s more than three times the annual contribution limit of individual retirement accounts (IRAs).

It hardly seems fair. Standing by and watching their employed counterparts receive matching contributions — which are effectively free money — only serves to exacerbate freelancers’ envy.

How to Mitigate This Challenge

As a self-employed American, you get access to a unique type of IRA: the SEP IRA. Along with the usual IRA or Roth IRA perks, account holders can contribute up to $58,000 each year, nearly 10 times as much as the traditional IRA contribution limit of $6,000. That’s also more than twice the contribution limit for employees under a 401(k).

Speaking of 401(k)s, if you’re a small-business owner, you can always create your own self-directed solo 401(k) through Rocket Dollar. You’ll need to hire a custodian to manage it for you, but you can enroll yourself and any employees you have, and you can invest in virtually anything you like through your self-directed 401(k) account. That includes the usual equity and bond investments but also real estate, private equity funds, and anything else you like.

Alternatively, you can consider opening a SIMPLE IRA as a small-business owner. It’s cheaper and easier than creating your own 401(k) plan.

Regardless of which course you choose, capitalize on the tax benefits of these retirement accounts, because you already face higher taxes as a self-employed person.

Challenge 2: Double FICA Taxes

The federal government charges 15.3% of each employee’s wages in payroll (FICA) taxes to collect for Social Security and Medicare. Traditionally, employers pay half of this — or 7.65% of paid wages — and employees have the other half taken out of their paychecks.

Self-employed Americans pay both halves.

Complicating matters, the self-employed must prepay these payroll taxes. Traditional employees don’t have to worry about this because their employer’s HR department simply deducts taxes from each paycheck, but self-employed people are on their own. They must forecast their annual earnings, calculate the appropriate tax rate, and make estimated quarterly payments.

If you pay too little, you suffer penalties from the IRS. If you pay too much, you lose valuable operating capital and must wait for the IRS to pay you back eventually — all of which makes it harder for you to budget and save for retirement.

How to Mitigate This Challenge

First, stay current on estimated quarterly tax payments. Fall behind, and you’ll discover firsthand just how little sense of humor Uncle Sam has about his money.

Pause at the end of each quarter and invest the time to forecast your income and deductible expenses and compare your past quarter’s performance to your previous forecasts. Besides helping you prepay your taxes accurately, it will help you measure your financial progress regularly so you can make adjustments.

As a self-employed person, you must take far more responsibility for your income than traditional employees. You don’t get a paycheck for showing up, so keep a close eye on your revenue and constantly brainstorm ways to improve it.

To ease the pain of paying double FICA taxes, look carefully at potential tax deductions for self-employed workers. You have more deductions available to you than the average employee, from home office costs to travel to legal expenses.

If you don’t know much about the deductions available to you, consider hiring an accountant, even if only to pick their brain for an hour, and ask targeted questions about your unique situation. If you don’t know any accountants, you can use H&R Block. They have professionals available to help you through your taxes.

And, of course, pump money into tax-advantaged retirement accounts. If you reach your contribution limit on your SEP IRA or self-directed 401(k), look for other ways to set aside money where it can grow tax-free.

For example, if you have children — or plan to — you can contribute money to a 529 plan or a UTMA account through EarlyBird, where it can appreciate and compound tax-free for your children’s future college tuition.

Challenge 3: Health Insurance

Health insurance is one of the great benefits of being employed by someone else. Sure, you have a boss telling you what to do all day, but you don’t have to pay hundreds or thousands of dollars per month for health insurance.

Data from Peterson-Kaiser Health System Tracker shows that annual health care spending increased more than six-fold between 1970 and 2019. In 2019 dollars, the average American spent $1,848 in 1970 on health care, a far cry from the $11,582 the average American spent in 2019.

With health insurance costs skyrocketing, many self-employed people are left wondering how the heck they can afford to set anything aside for retirement.

How to Mitigate This Challenge

The self-employed are on their own for health insurance — not just paying for it, but also navigating thousands of opaque options. Should you opt for a high-deductible health plan with low monthly premiums or vice versa? Should you consider an HSA through Lively? Where do you even start looking for providers?

Start on the federal health insurance marketplace. If you’re a small-business owner, you may find some attractive options in the Small Business category. If you’re a freelancer, take a look at Freelancers Union, which also offers supplemental plans such as dental and other policies like life insurance. Often, these collaborative health insurance options prove cheaper because they allow for collectively negotiated rates due to volume.

As another avenue for volume-negotiated self-employed insurance plans, check with your local chamber of commerce or trade associations.

If you have an employed spouse, they may be able to add you to their coverage. I am among this group and count my blessings for it nightly.

Finally, look into subsidies and tax credits, such as the Advanced Premium Tax Credit when you buy health insurance on the government marketplace.

Challenge 4: No Paid Time Off

Everyone needs time off from work so they can avoid burnout and return refreshed and motivated. Self-employed people need their R&R more than anyone — it’s stressful living without the safety nets and support services employees have in place. But the self-employed get no paid time off. When they’re not working, they’re not earning.

All too often, hardworking freelancers and small-business owners delay taking time off, brush dangerously close to burnout, and then blow off steam by spending absurd amounts of money. That’s money they could have invested for retirement.

How to Mitigate This Challenge

First, freelancers and solopreneurs should budget for vacations differently from employees. Instead of only budgeting for incurred costs, they must also budget for lost income. Otherwise, that lost income typically comes out of savings, which is bad news for retirement planning.

By budgeting for vacations, the self-employed can plan time off regularly instead of reaching burnout before going on a wild last-minute jaunt.

Bear in mind that travel doesn’t have to look like the traditional one- or two-week family vacations popular among employees who must report for work in person. If you can work remotely, working vacations are an alternative that allows you to continue earning while you enjoy some time off.

As a school counselor, my wife only works about 180 days per year. She has several months off in the summer and wants to travel, but I can’t take months off at a time. Our compromise has been to live in a foreign country for a month. She gets to explore and be a tourist, and I work remotely and get to join her in the evenings and on rare days off.

This travel costs little more than the airfare. We rent out our home through Airbnb while we’re not using it, which covers most or all of our housing costs while we’re traveling. And while we eat out at restaurants more than we do normally, we also do plenty of cooking because we rent apartments with full kitchens on Airbnb.

You could also compact your travel into long weekends. You could, for example, work four 10-hour days leading up to a long weekend trip rather than five eight-hour days. That way, you get to fully immerse yourself in your travel without losing any work hours.

Challenge 5: Inconsistent Income

As all freelancers and small-business owners know, not all months are equal when you work for yourself. You have good months and bad months, sometimes with enormous income swings. Fluctuating income makes budgeting a far greater challenge for the self-employed compared to employees with stable paychecks.

How to Mitigate This Challenge

When you create a budget, use a tool like Tiller and start based on your minimum reliable monthly income. Sure, you might make $10,000 in some months, but if you only earn $2,500 in others, then your budget should be based on $2,500 per month.

Whatever you earn above your minimum revenue, you can sock it away for a rainy day. Put it toward your retirement accounts, your travel budget, or your emergency fund (more on that shortly). But don’t leave your retirement investing solely to the good months. Hoping you’ll have an extra $6,000 lying around by the end of the year to put into an IRA is not a strategy, it’s an idle hope.

In your regular monthly budget, based on your minimum reliable income, set aside some money for retirement savings. Decide on a retirement savings rate, and then set up automated transfers to regularly shunt money into your tax-advantaged retirement accounts. Beyond establishing consistent retirement savings, it also helps reduce risk through dollar-cost averaging and gradual investments, rather than irregular lump-sum investments.

Challenge 6: Less Income Security

Freelancers and small-business owners could lose their jobs tomorrow if their regular clients and business dry up. With less consistent income comes the risk of prolonged periods of low or no income.

Small-business owners in particular struggle to save money for retirement when they feel a constant need to funnel revenue back into their businesses to keep them afloat. Again, the nebulous needs of a far-distant retirement pale in comparison to the need to stay in business for the next week, the next month, and the next year.

How to Mitigate This Challenge

As with so many other strategies on this list, planning is the key to managing income insecurity.

First, self-employed people need a larger emergency fund than the average employee. While many people can get away with one or two months’ expenses in their emergency fund, freelancers and small-business owners need a bigger buffer.

They may go many months with little income if their business sees a sharp decline. It takes time to find new clients and implement new marketing strategies – time you’ll only have if your emergency fund is deep enough to keep the lights on during the lean months.

Guess where many self-employed people turn in their moments of desperation when they don’t have emergency funds? You got it: their retirement accounts.

It also helps to have minimal mandatory living expenses. One strategy to cope with inconsistent and insecure income is to maintain flexibility in your spending. For example, housing is the greatest expense for most people, so one way to lower costs is to house hack to cover part or all of your housing payment.

Another option is to diversify your income streams. In addition to investing in your retirement accounts, invest for passive income to generate income from additional sources, not only your business or freelance gigs. Try one of these strategies for earning passive income to start earning more.

Pro tip: If you don’t have an emergency fund, open one today. Put the money in a high yield savings account like CIT Bank. This way the money is available, if needed, and you’ll earn a little interest on the account.

Final Word

When you work for yourself, you take on far more responsibility than the average employee. You’re your own HR department, responsible for finding and paying health insurance, creating your own retirement accounts, and setting aside and prepaying estimated taxes. There’s no corporate support and no safety net, just you and your ability to plan for rainy days.

And rain it will. If you go without health insurance, the day will come when you need immediate medical care. If you postpone investing for retirement, you lose the greatest asset you have: time for compounding to work its magic.

It takes far less money on your part to retire if you start young. Consider that if you invest every month for 40 years, it only takes $310 per month to reach $1 million. But if you blow it off and only start investing when you’re 10 years away from retirement, you’ll need to invest $5,552 every month to reach that million-dollar nest egg.

Yes, it’s harder to save for retirement when you’re self-employed. But you still need to do it, and for every month you don’t invest for retirement, the more you need to invest every month moving forward. Get back on track with better planning and leverage every last day out of your remaining career to capitalize on compounding.

G. Brian Davis is a real estate investor, personal finance writer, and travel addict mildly obsessed with FIRE. He spends nine months of the year in Abu Dhabi, and splits the rest of the year between his hometown of Baltimore and traveling the world.

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