Last Updated on March 3, 2023
As a freelancer, your employers are probably not going to handle your retirement plan for you. Just like how you entered the industry and did your work on a regular basis, you are on your own.
That is, of course, not entirely a bad thing.
As the “gig economy” rises, startups and SMEs get access to a global pool of independent talent in exchange for flexible employment opportunities. Furthermore, freelancers develop the skills necessary to take care of themselves and are encouraged to explore other avenues for financial growth—from investing online to founding their startups.
When it comes to retirement plans, however, not many freelancers know their options. In fact, it is common for freelancers to be behind in their retirement funds. According to a study in 2015, 37% of freelancers are concerned about their retirement.
If you do not want to work for the rest of your life, one of the more dependable retirement vehicles you need to consider is the Solo 401(k).
What is the Solo 401(k)?
While full-time employees have the corporate-sponsored 401(k) plan, freelancers have the Solo 401(k), also known as Individual 401(k). It is a popular retirement option for self-employed individuals. With this retirement plan, you can contribute up to $18,000 annually.
There are two types of Solo 401(k):
- Elective – An elective Solo 401(k) means you are not obliged to contribute.
- Non-elective – A non-elective Solo 401(k) means you are required to provide as planned.
Aside from the annual contributions, you may also invest 25% of your freelance business’s income or your net earnings as a self-employed. A total of $53,000 annually can be contributed while individuals 50 years and older have the option to add an extra $6,000 as a “catch-up” contribution.
Also, you can start contributing to your 401(k) as early as the time you start working professionally. The important thing to consider when placing money to your retirement plan is to contribute as much and as early as possible so you can enjoy the perks of maxing out your 401(k) account. Speaking of which…
Benefits of a Solo 401(k) Plan
Having the ability to add 25% of your income as a contribution is one of the aspects that made the Solo 401(k) plan an attractive retirement vehicle. Additionally, it is a tax-deferred retirement plan, which means you do not have to pay income tax unless you cash out from the scheme.
The flexibility of a Solo 401(k) plan is also a nice advantage for freelancers especially for those who do not consider their income as reliable. That means it is also easy to align your retirement plan with your current tax planning strategy. Just remember that, with a Solo 401(k) plan, you can contribute up to 100% of your earned income as elective deferral.
How to Invest in Solo 401(k)?
First of all, you need to be aware of the eligibility requirements to start investing in a solo 401(k) plan. Fortunately, there are only two things you need: self-employment activity and the absence of full-time employees.
Self-employment activity denotes sole proprietorship, offering consultancy services, being an independent contractor, or running a home-based business. The lack of full-time employees, on the other hand, is rather self-explanatory—you must have no full-time employee working for your business other than yourself.
With a Solo 401(k) plan, you are required to file an IRS Form 5500 once your assets exceed $250,000. Apart from that, there are no compliance testing requirements, as opposed to regular 401(k) plans.
When it comes to the registration process, it is best to consult Solo 401(k) providers firsthand to obtain clearer instructions and technical details. You can search online for Solo 401(k) providers who can help you get started. Keep in mind to look for providers that deal with investments you are familiar with such as real estate, mutual funds, annuities, and equities.
Tips for Building your Contributions
Keep in mind that a retirement plan is not the only thing you need to consider if you want a stable future as a freelancer. Pay attention to other factors that can significantly impact your cash flow and therefore affect your finances in the long-term.
Below are some of the factors you need to consider:
Needless to say, paying off high-interest debts should come first before putting money into a retirement account. As a rule of thumb, make sure only 20% of your freelancing income goes directly to either your retirement savings account or an outstanding debt.
According to David Blanchett, head of retirement research at Morningstar Investment Management, contributing to your retirement while using credit cards is “disastrous” for building wealth.
One of your most valuable assets as a freelancer is your portfolio. Take note that, unlike full-time employees that rely on promotions or better job opportunities for growth, you are solely responsible on how to enlarge your income. If you skip building a portfolio, you are more likely to hit a dead-end in the freelancing industry.
A typical route for most freelancers is to build an online portfolio, which is made easier thanks to countless DIY site builders such as SquareSpace. With an online portfolio, you can tap into the power of the internet to expand your network and reach the international clientele.
A good strategy is to invest in content creation to build your brand as a freelancer. Most freelancers start a blog which serves as a primary content distribution channel and a powerful tool for networking. It can also help them attain thought leadership in a particular niche.
Don’t Forget Your Taxes
Taxes are a lot more tedious for freelancers than regular employees. You must first file your self-employment, keep track of your income, calculate your taxes, and pay them yourself. As a result, some freelancers choose to ignore taxes completely—only to pay for it dearly later.
To avoid tax-related problems in the future, here are some of the things you need to remember:
- Self-Employment Tax – A self-employment tax is required for those who earn more than $400 a month. This amount goes straight to social security and Medicare.
- Quarterly Payments – Take note that most freelancers are required to make quarterly tax payments. To file them, you can use the IRS’s 1040-ES form.
- Annual Tax Return – You request for the Schedule C form if you have less than five employees in your freelancing business (applicable for Solo 401(k) plan holders).
- Deductions – Lastly, make sure you are aware of all the tax deductions you are eligible for as a freelancer.
Preparing for the future as a freelancer is not a walk in the park. You need to understand accessible options like the Solo 401(k) and develop a solid plan that will help you hit your objectives.