According to a study by Upwork¹, more than 57 million Americans make a living freelancing. It is a workforce trend that is here to stay and is being increasingly adopted among younger people, who value the flexibility and independence it can provide.
Though freelancing can be great for certain things, like control over where you work and when, it does lack some of the beneficial infrastructure of traditional employers, in particular the ability to automatically save a portion of your paycheck in a 401k, 403b, or other type of retirement plan.
With the decision to freelance comes the responsibility to take the initiative on planning, saving, and investing to fund your own retirement. But in my experience, most freelancers have trouble planning their finances through the next year, let alone a retirement that could be decades away.
What are freelancers, a generally young and financially inexperienced group of people who already live hectic lives bouncing between gigs to do when it comes to taking on an increasingly complicated issue like saving for retirement? There is a certain reality that some freelancers are only going to be able to take care of their to do list for the day and will likely put off things like saving for retirement indefinitely.
That is a huge mistake. The dollars you save in the early years have the potential to grow the most, so saving early is by far the best “retirement saving hack” you can implement. Save early and let compounding do its thing; it is a way easier route than the alternative of having to save more later to catch up.
But sometimes it is tough to know where to start, even just the basics of opening investment accounts to save for retirement can be overwhelming enough to deter people, let alone figuring out how much to save and how to invest your money for retirement.
In this blog post, I hope to provide a path forward for freelancers who may be curious about saving for retirement, whether you are a do-it-yourselfer with your money or would prefer to have somebody help you.
Before saving for retirement, set aside at least 6 months expenses cash
The textbook financial planning recommendation for how much people should set aside in an emergency fund is 3-6 months in cash.
I personally think freelancers, who have very inconsistent income should err on the higher side of that number. Adjustment periods after work for a certain client dries up or full on droughts seem to be common among freelancers, and they seem more likely to rely on an emergency fund in any given month or year. Even a partial loss of freelance income can have people dipping into reserve funds.
There is no perfect science, but set aside enough to get you through a major drought without having to sell your house, withdraw from retirement funds, etc. You simply can’t move on until you have this foundation.
And Taxes Too
Set aside enough for your yearly taxes – and yes, I know many of you go with the plan of figuring it out when the time comes. But you don’t want to put all your money into retirement savings accounts only to have to withdraw it to pay your taxes. If you want a more accurate answer, you can look at your tax bill in past years and make an educated guess of your tax rate and withhold that percentage of each payment you receive. Even better, get the help of a CPA to decide how much to set aside. If you have to pay quarterly estimated taxes, makes sure to always have enough set aside to make those payments as well.
If you have any left over at the end of the year, use it to replenish your emergency fund, or even more fun, save/invest it for retirement, which brings me to the next step.
When it comes to saving/investing for retirement, you will ultimately have to decide to do everything yourself or outsource the process to someone else. Let’s start with people who want to do it themselves.
I’ll Do It Myself
If you are the type of person that likes doing everything yourself, that’s great. In order to get serious about saving for retirement, you need to first open some type of investment account to save in, fund those accounts with contributions, and ultimately invest those contributions in a globally diversified portfolio of stocks using mutual funds or ETFs. Let’s start with possible account types.
Self-employed people who have no employees (or only employ their spouse) can actually set up their own 401k account called a “Solo 401k.” Like any employer-sponsored retirement plan, a Solo 401k allows you to set aside money and invest it for retirement, receiving special tax benefits for doing so.
You can set it up as a traditional Solo 401k or a Roth 401k.
Traditional 401k contributions allow you to save money on taxes now, as contributions you make can be deducted from your income and lower your tax bill. The money then grows tax-deferred (you don’t have to pay taxes on the growth in the account), but you will pay income tax when you withdraw the money. Roth contributions are the opposite. You pay taxes now (you can’t deduct contributions and lower your taxable income), the money grows tax deferred, but with Roth contributions you do not have to pay taxes when you eventually withdraw the funds.
Which you choose depends on whether you think you will have a higher tax rate now or when you withdraw the money, which in many cases is impossible to guess. If you have a very low taxable income now, the Roth may be the better option, if you have a high income, Traditional may be better.
The good news is, which of these you choose doesn’t really move the needle as far as achieving your retirement goals, how much you contribute and how you invest within those accounts has a much bigger impact.
One of the benefits of Solo 401ks is the high contribution limit, as you are acting as both the employee and employer. You can contribute up to the normal 401k limit of $19,500 as the employee, as well as an employer contribution up to 20% of your net earnings, or 25% of total wages paid as the employer. Your total contribution cannot exceed $57,000 if you are under ager 50, after which you can make an additional catch up contribution of $6,500 for a total of $63,500.
Solo 401ks are relatively inexpensive to set up, and several companies have good options. Deciding which to choose is worth a blog post itself, and fortunately, somebody else already covered it. I think this blog from The College Investor does a great job breaking down the most popular options:
Simplified Employee Pension Plans or SEP-IRAs for short, are functionally similar to Solo 401ks in that they allow a self-employed person to save for retirement and receive special tax treatment, but lack some of the legal and administrative requirements of running a 401k. With SEP-IRA’s you may have more control over investment selection, but you can only designate SEP-IRA contributions as traditional, tax-deductible contributions and won’t have the ability to make Roth contributions. Contribution limits are the same as Solo 401ks ($57,000 per year) but with no catch-up contributions for those 50 or older.
Roth or Traditional IRA
You may want to consider opening a Roth or Traditional Individual Retirement Account or (IRA for short).
A side benefit of a Roth IRA is the ability to get your contributions out at any time without penalty or taxes. It should only be used as a last resort, but nice to at least have the option.
IRAs are limited in how much you can contribute each year – the combined limit for both Roth and Traditional IRAs for 2020 is $6,000 ($7,000 if you are 50 or older). Roth IRA contributions are limited or eliminated at higher incomes, and the deductibility of Traditional IRA contributions may be reduced or eliminated based on your income and if you or a spouse is covered by a retirement plan at work.
Opening a Roth or Traditional IRA is very easy with any major broker, I particularly like Schwab, Fidelity, and Vanguard. They can generally link a bank account to these accounts, which makes it easy to transfer money from your checking account to your retirement savings account as easy as any other electronic transfer.
Taxable Brokerage Account
If you are past the max contribution for IRAs or over their income phase-outs, you can contribute to a regular taxable brokerage account. This account receives no special tax treatment like Roth and Traditional IRAs – and it is important to note if you buy something in this type of account and later sell it at a gain, you will owe taxes on that gain in the year you sold. You will owe taxes on dividends, interest, and capital gain distributions from the holdings in the account each year. But don’t let the word taxable and the idea of paying taxes scare you, taxes on dividends, interest, and capital gain distributions are something to consider but aren’t likely to be a huge issue in the grand scheme of your finances. And if you simply buy and hold an investment and it increases in value you won’t owe taxes on that gain until you sell it.
You are in no way limited to how much you can contribute to a regular brokerage account.
How to invest?
Once you have opened and contributed to a brokerage or retirement account, you will need to invest that money so it can grow.
I think young people who are investing for retirement should invest in 100% stocks (no bonds or cash), doing so by spreading their money among thousands of companies around the globe using diversified mutual funds and ETFs – fancy names for types of investments that invest in large groups of individual stocks all in one “wrapper.” There are even great options to invest using only one fund – quite frankly, someone could buy The Vanguard Total World Stock ETF (VT) that invests in over 8000 companies all over the globe and call it a day.
Taking things one step further, I believe young people should concentrate more heavily on higher-risk, higher-return groups of stocks. I’ve written extensively on why I believe this (I wrote about how I invest my money and why in this CNBC article: This 29-year-old advisor puts his money where his mouth is), so I’ll save you the lesson and just give you the portfolio:
25% US Total Stock Market
25% US Small Cap Value
25% International Small Cap Value
25% Emerging Markets
To invest in these four “asset classes,” you will need to find mutual funds or ETFs that invests in each of these asset class and invest in them. It sounds complicated, but they will be named something that makes it obvious, for example, Vanguard Small Cap Value Index, or iShares Emerging Market Index. I recommend looking for “index” funds that represent these asset classes as they passively own a basket of stocks and don’t try to beat the market, and will generally be low cost and well diversified. Almost all the major fund families will have these options, and they are more or less the same thing so don’t get lost choosing between them.
In order to invest in this portfolio, you will need to place trades to buy the individual mutual funds or ETFs. Generally speaking, online brokers like the ones I mentioned earlier make this pretty easy.
If you are investing small amounts, you may not have enough to invest in all 4 mutual funds or ETFs each time. It is ok to buy just one each time you have money. Over time, try to reasonably use your contributions to “rebalance” the portfolio back to the weights above. If for some reason one fund is only representing half of what it should in your portfolio, buy that one.
How Much to Save?
I mentioned earlier how much you save has perhaps the biggest impact, but how is a person who is not a financial planner supposed to come up with that number?
That is a great question, and one I can’t possibly answer in the scope of one blog post. But I can provide some thoughts on generally how we think about retirement, and some rules of thumb on how much you can withdraw from your investment portfolio to give you an idea of how much you’d need to retire.
As a rule of thumb, retirees can withdraw around 4% of their portfolio each year. Our team has written entire blog posts about not trusting the 4% rule and why it is overly conservative (see this one by David Ruedi, CFP®: You Can’t Rely on the 4% Rule) , but for the back of the envelope math, it will work.
In retirement you will need to use your retirement portfolio to fund a certain amount of spending. To arrive at how large of a portfolio you need to retire, you simply divide that number by 4%, or multiply by 25. For example if you need $40,000 per year to live on, you would need a 1 million dollar portfolio to fund that. If you need $80,000 to live on, you’ll need $2 million.
Then the math just becomes a matter of figuring out what it takes to hit that critical mass by the time you want to retire. There are plenty of online calculators to do this. If they ask you to input an investment return I’d just use 10% for a 100% stock portfolio – that may sound high, but historically speaking it may actually be conservative.
But as a blanket statement without overcomplicating the math I always recommend, within reason, to save as much as possible as early as possible!
I would need some help with that…
Does opening investment accounts, placing orders to trade mutual funds, and deciding how much to save sound like a huge pain? Nobody knows that better than us! That is why you may want to outsource the process to a financial advisor or robo-advisor service.
Robo-Advisors are online investment management platforms that include automated, computer-based financial planning and investment management services. The first robo-advisor (Betterment) launched in 2008, and since then several other major robo-advisors such as Wealthfront and Personal Capital have grown to manage billions in client money. At this point the robo-advisor concept has been taken up by many major asset management and brokerage firms as well, with Schwab, Blackrock, Vanguard, Fidelity, TD Ameritrade and Fidelity all offering a type of robo-advisor or hybrid option. Most have very low minimal initial investment requirements, and several have no minimum at all.
Robo advisors allow you to easily open and contribute to investment accounts, and generally provide diversified “model portfolios” you can choose from based on the level of risk you want. For young investors, I’d choose whatever option has the greatest percentage in stock or “equity.”
They automatically do some other functions like rebalancing your portfolio to target weights. They even allow you to do some basic financial planning and retirement planning to help you make decisions about how much you need to save.
“Talk to a financial advisor”… is it that easy?
I’d love to make the blanket recommendation to “talk to a financial advisor,” but young people with very little to invest and inconsistent incomes have generally had a hard time finding traditional advisors who will work with them as many have minimum asset requirements.
For many freelancers, working from home, or wherever they may be, is of prime importance, and having to meet in a physical office may not work for them either.
Fortunately, with the rise of robo-advisors and the ability to give advice online, some hybrid options have popped up, where a financial advisor can use a robo-advisor and provide advice online. Many traditional advisors are starting to launch these online services - we launched ours (Ruedi Wealth Co-Pilot) last year and have been surprised by the initial momentum of new clients on the platform.
Hybrid Options: Ruedi Wealth Co-Pilot
Robo advisors can automate many things, but they can’t do everything a person can do. Ultimately it will be up to you to choose your investment portfolio, create your own retirement saving plan, and see that plan through. Sounds easy in theory, but in practice many people, especially those with different things competing for their attention, have a hard time motivating themselves to take action and actually implement their financial plans. Even if they do take action, they may struggle to sort things out when confronted with a financial curve ball that changes their plans.
Ruedi Wealth Co-Pilot combines an automated investment management platform (we actually use Betterment) with a personal financial advisor that will quarterback your financial planning and investment management process. Your advisor will help you open and link your accounts, build a financial plan based on your goals, and help you choose a portfolio to fund those goals. After that, they will check in occasionally just to see how things are going, and will always be just a phone call away any time you have a question or issue come up and need to make adjustments.
As a freelancer you are used to taking responsibility for your own success, and planning for your retirement is going to take some of that same initiative that allows you to live the lifestyle of a freelancer, instead of being tied to a schedule working for someone else.
There are a couple different routes you can take, and my strongest advice is whichever route you choose, make sure you don’t delay and miss out on the early years of saving and retirement planning that give you a huge head start towards your goals.
Do it yourselfers – open your retirement accounts and get saving. People who need help – start looking for your person, or service. You’ll be glad you did.
Paul R. Ruedi, CFP® is a financial advisor at Ruedi Wealth Management in Plano, Texas.
Paul has been quoted in news publications including USA Today, Time Magazine, The New York Times, Dallas Morning News, Forbes, Inc.com, Business Insider, US News and World Report, GoBankingRates, The Street, NerdWallet, and The Penny Hoarder. He also writes articles that have been featured in CNBC, Investopedia, Yahoo Finance, Nasdaq, and MSN Money. He was named one of Investopedia's Top 100 Most Influential Financial Advisors in 2018.
Previous Posts by Paul R. Ruedi, CFP®
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- The 9 Biggest Threats to Your Retirement
- Should I Invest in Marijuana Stocks?
- Lost Investment Accounts
- How to Use Your 401(k)
- Why People Switch Financial Advisors
- Your First Meeting With a Financial Planner
- The Retirement Mountain
- What is Wealth Management?
- Ship of Fools
- The Richest Person in the Graveyard