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A Freelancer's Guide to Planning for Retirement

This post is part of a series called Freelance Financial Bootcamp.
A Freelancer’s Guide to Getting Paid on Time

36 percent of Americans aren't saving for retirement—that's according to a recent poll conducted by Princeton Survey Research Associates International for Bankrate's monthly Financial Security Index. Among freelancers, who typically have no pension plan or option for employee 401(k) matching, the number may be even higher.

Many freelancers put off thinking about retirement. That's a big mistake, because the sooner you start planning for your retirement, the more comfortable you'll be.

If you freelance, your financial future doesn't have to be at risk.

A little retirement planning now goes a long way towards securing your financial future. There are small, easy things freelancers can do that will make a big difference. As a freelancer, your retirement is probably the last thing on your mind. That doesn't mean you should ignore it. Whether your retirement is decades away or just around the corner, the time to start planning for your retirement is now.

In this tutorial, I identify the three biggest retirement mistakes freelancers (and others) make. I also talk about three different ways to fund your retirement.

Note: This tutorial provides general information. It is not a substitute for personal legal, tax, or financial advice. If you have specific questions about your own financial situation, please contact a financial advisor.

3 Retirement Mistakes Freelancers Make

Freelancers tend to make some serious mistakes about retirement. Here are three of the most common:

  1. I'll never want to retire.
  2. I can live on government retirement funds (such as Social Security).
  3. I can't afford to save for retirement.

Maybe you recognize yourself in the statements above. If you do, stay tuned as we examine each mistake separately.

Will You Want to Retire?

You love what you're doing now. You'll be happy freelancing forever (or so you think). So, why worry about retirement? The answer is simple. Things may not turn out the way that you expect them to.

According to a Health and Retirement Study conducted by the National Institute on Aging, 35% of those who retire between the ages of 55 and 59 do so because of health problems.

Of course, no one wants to think about becoming too sick to work. But the numbers show that it sometimes happens. It's better to be prepared, than to be taken by surprise.

Can You Live on Social Security?

In the U.S., many freelancers count on receiving Social Security when they retire. Is it really possible to live on just Social Security? Let's take a look.

It's hard to predict what future Social Security payouts will be. Let's look at current figures from the Social Security Administration. If you retire in 2015 at full retirement age, your current maximum monthly benefit (not including any spousal income) would be $2,663. If you retire in 2015 at age 70, your current maximum monthly benefit amount would be $3,501.

That's not too bad, you might think. If I wait until I'm 70 and I'm very careful, I could live off that.

Maybe, except that's the maximum payout. Most retirees don't earn enough during their working years to qualify for the maximum payout. Philip Moeller, writing on Time.com, explains what it takes to qualify:

A worker needs to have wage earnings large enough to equal or exceed the agency’s annual ceiling on earnings subject to payroll taxes for at least 35 years.

Very few people earn enough to receive the maximum monthly social security payout when they retire. A more realistic monthly income figure is $1,335.97. That's the average monthly social security retirement benefit paid out to a retired worker in July 2015 according to Social Security's own figures. It would be hard for most of us living in the U.S. to make ends meet on that amount and nothing else. 

Can You Afford to Save for Retirement?

It's hard to save when your income varies from month to month. Yet, that's the reality for most freelancers. Tuts+ has a great tutorial on how freelancers can budget their income, even when it varies from month to month.

While retirement savings may be the last thing on your mind, this is one area where even a little bit can help. And the sooner you start, the better. Let me show you.

Let's imagine you spend $5.00 a day getting coffee or on fast food. At the end of the month you'll have spent $150. ($5.00 x 30=$150)  Let's look at what else you could do with that $5.00 a day.

A better use of your $5.00 a day is to invest it for retirement. There are a number of retirement calculators out there, but I used the calculator at the US Department of Labor for this example.  Your results may vary if you use a different calculator.

Assuming a 27-year old single freelancer with no current savings, I plugged a retirement age of 67 into the calculator. The freelancer has 40 years until retirement. An annual contribution to the account of $1800 (the $150 a month from earlier) would result in a savings account of $182,440 upon retirement. This adds $1025 to the freelancer's monthly retirement income each month (with no survivor benefit). Not bad for an investment of $5.00 a day. 

To show how important it is to get started early, let's look at the same example with a 47 year old single freelancer. The freelancer contributes the same amount, but they only have 20 years only retirement. This time the freelancer's retirement savings account is only $58,699. This adds measly $330 (with no survivor benefit) to the freelancer's monthly retirement income.

Can you afford to save $5.00 a day for retirement? I think the real question is, can you afford not to?

So how should you save? Well, you could just invest the money in a money market fund. A better alternative is to set up a tax-deferred retirement fund.

 IRAs and Other Saving Funds

If you were a traditional employee, you could contribute pre-tax dollars to a 401(k) retirement savings plan. Your employer would even match some of your contributions. Although it's becoming rare, it's possible that you would also take part in a pension plan.

Self-employed freelancers don't have these options, but that doesn't mean that they can't prepare for retirement. They can even enjoy some of the tax advantages of saving for retirement. Currently, the IRS lists several retirement options for the self-employed. Here are three of them:

  1. SEP IRA. A small business owner who has one or more employees can open a SEP. This plan allows you to contribute the lesser of 25% of your net income or $53,000 (in 2015). You can make contributions until the due date of your tax return. Also, you don't have to contribute to the plan every year.
  2. Solo 401(k). This plan is designed for a business owner (or a business owner and their spouse) with no employees. You can contribute to the plan as both the employer and the employee. As the employee you can contribute up to $18,000 in 2015, or $24,000 if you are over 50 years old. As the employer, you can contribute up to 25% of compensations defined by the plan. To learn more, review the IRS requirements.
  3. Simple IRA. A Simple IRA plan works like any other IRA. You cannot use this plan if you have another type of retirement plan.  Once you start, you must contribute a certain amount each year. To learn more, review the IRS requirements.

Which option is best for you? It depends on your situation. Factors like whether you can contribute to the fund regularly and even your age make a difference.  Whichever plan you choose, be careful about withdrawing money too soon. In most cases, taking an early withdrawal results in extra tax. 

If you are over fifty, you may be able to contribute more than the minimum to your retirement plan. The IRS calls this catch-up contributions. Check with your financial advisor to find out whether your plan allows them.

Retirement Income Streams

Besides setting up a retirement savings fund, freelancers can develop extra streams of income through property rental or product sales.

After you've retired, having extra income helps. There are several ways that freelancers (and others) can generate more income. Here are two of the most common and some of the pros and cons of each.

Owning Rental Property

You can enter the real estate market by investing in an additional home to rent. Or, you  may decide to downsize and move into a smaller property while renting your current home. Whichever choice you make, getting rent money each month increases your retirement income.

There are benefits to renting property, besides the extra monthly income. Here are a few of the tax advantages of being a landlord according to MarketWatch:

  • You can deduct mortgage interest.
  • You can deduct real estate taxes.
  • You can depreciate the cost of the build over 27.5 years.
  • You can write off related expenses such as insurance and repairs.
  • You don't have to pay self-employment tax on rental income.
  • When you sell the property you've held for more than a year, your profit is treated as a long-term capital gain.

Before you decide that becoming a landlord is for you, you should understand the drawbacks. A friend of mine has rental properties and I've heard about some of the struggles firsthand:

  • renters who don't want to pay
  • renters who damage your property
  • the cost of repairs and maintenance
  • the lost income when a unit sits vacant

These are hassles you may not want to deal with once you've retired. You could hire someone else to handle these problems, but paying a property manager reduces your monthly income.

Product Sales

Product sales may seem a natural source of retirement income for freelancers, who are already used to working on side projects. Many freelancers create a product (such as an app), create a membership site, or write an eBook to get added income.

Tuts+ writer Xavier Russo takes a realistic look at side projects in his tutorial, In Praise of Side Projects. As Xavier honestly points out, many startups fail.

Also, income from product sales isn't completely effort free. To stay competitive you need to continue:

  • upgrading your project (updating it if an eBook, adding new features if an app)
  • marketing your product to build interest
  • responding to client questions and problems
  • updating your product's website

Of course, you could sign up to sell someone else's product. There are many companies that pay a commission for products sold. But, as you know from freelancing, sales can be hard work.

So, while product sales can add to your income, there's no guarantee you'll succeed.

Investing in Things

The purchases you make now could increase in value and later be sold to help finance your retirement. Let's look at two assets that are likely to grow over time:

Your Home

Many retirees sell their homes when they retire. The strategy is to use the sale proceeds to buy a smaller home and pocket the difference. This can be a good move if:

  • Your home is mostly paid off.
  • Your home has increased in value.
  • Your home is larger than you need.
  • You live in a high-demand area.
  • You are moving to an area where homes cost less.

While selling your home may seem like a good solution to bolster your retirement account, remember that it depends on market demand and property values. There may also be hidden costs to selling your home. Writing on SmartAsset, Gregory Erich Phillips describes the following hidden costs:

  • real estate commissions
  • paying the buyer's closing costs
  • tax and insurance
  • home improvements
  • moving costs

What else could you have that might go up in value? What about collectibles?

Your Collectibles

I love to watch the reality TV shows where someone finds a valuable antique in their attic/garage/storage shed. Usually, they act totally surprised. I had no idea it was worth so much money, they say in amazement.

Although luck like that makes good TV drama, it's relatively rare. To make money with collectibles you really have to know what you're doing. Not everything that is old is valuable. It could take years for your collection to become valuable. It might not even happen in your lifetime.

Plus, there are counterfeit antiques that look real, but are practically worthless. Most people can't tell the difference between a real antique and a fake. Condition is important too. That childhood toy might be worth something if it were in mint condition. But most of us played with our toys. The same toy, beat up and missing parts, is worth a lot less.

Collecting antiques and other collectibles can make a great hobby. However, many experts caution against trying to fund your retirement this way.


What should you do next?

The key is to do something. Start by finding out how much social security you will be eligible for when you retire. You can get an estimate of your future benefits based on your current lifetime earnings by typing information into the Social Security Retirement Estimator.

Contact a financial advisor and put a retirement plan in place. Start saving a little bit each month. Soon you'll have a healthy and growing retirement fund.

Remember, when it comes to retirement, doing something is better than doing nothing.


Graphic Credit: Retired icon designed by Lemon Liu from the Noun Project.

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