When you’re self-employed, the burden of saving for retirement falls entirely on you, which can be a bit daunting. At the same time, being self-employed allows you total freedom over your financial future; you can more-or-less decide how much to contribute to your retirement fund as well as what type of retirement account will best suit you.
If you’re self-employed and beginning to consider your retirement options, however, there are a few common mistakes you’ll want to avoid.
1. Waiting Too Long to Open a Retirement Fund
A lot of times, self-employed individuals put off opening up their retirement fund for any number of reasons. Some will procrastinate when they’re newly self-employed because they’re not sure how long they’ll be working independently, or whether this will be a permanent career move for them. Others will put off opening a retirement fund because they simply don’t know where to begin.
One of the biggest mistakes to avoid, however, is putting off opening a retirement fund because you don’t have a lot of money to put into it right off-the-bat. One of the great things about many self-employed retirement options is that you often don’t need a huge amount of money to get started; many accounts can be opened with an initial investment of $1,000 or less, and you aren’t obligated to contribute a set amount of money each month.
No matter where you stand financially, opening up a retirement fund sooner rather than later will always serve you well. Remember the power of compounding interest. Even small contributions throughout the year can add up big time when your retirement date rolls around!
2. Failing to Research Your Options Thoroughly
There are a few common retirement accounts that are generally recommended for self-employed workers, but you’ll want to carefully research each option and consider your own unique needs/finances before you decide on anything specific. By understanding the differences between three of the most common retirement accounts for self-employed workers, you can make a better informed decision for your own needs.
- Solo 401(k) – This type of retirement account is meant for those who own sole proprietorships or businesses where there is only one other employee–and that employee is a spouse. The contribution limits for a Solo 401(k) are $18,500 annually, though “catch-up” contributions of an additional $6,000 are allowed for those age 50 or older.
- Simple IRA – A SIMPLE IRA can be used by both sole proprietorships and businesses with multiple employees. The annual contribution limit for this type of IRA is $12,500, with a catch-up limit of $3,000. This is a great plan for small businesses and self-employed workers who want to offer a retirement plan option to their employees.
- SEP IRA – This is similar to a SIMPLE IRA with the main difference being that contribution limits are based on your annual earnings rather than a set amount. The annual contribution limit is 25% of your net earnings from self-employment up to a maximum of $55,000, though there aren’t any catch-up contributions permitted with this type of account.
3. Dipping Into Your Nest Egg Early
No matter which type of self-employed retirement account you end up choosing, it’s important to remember that there are strict regulations in place regarding when you’re allowed to begin withdrawing from your account. For most types of retirement accounts, you will need to wait until you’re 59.5 years old to begin withdrawing without any type of penalties. If you need to dip into your nest egg early, keep in mind that you will likely face some hefty penalties. For example, withdrawing from an SEP IRA before age 59.5 can result in a penalty of up to 10%, along with any taxes that you will be subjected to at the time of withdrawal.
With this in mind, it’s important to plan for your retirement accordingly so you don’t need to dip into your savings early. Otherwise, you could be wasting some of your hard-earned money.
4. Forgetting About Social Security Benefits
As you’re calculating how much money you need to save up for your future retirement, don’t forget that you will most likely be able to collect Social Security benefits in addition to earnings from your retirement fund. This is a common mistake that self-employed individuals make, especially since there is no pay-stub with automatic Social Security deductions reflected to remind you that you’re still paying into Social Security.
However, when you’re self-employed, you’re still contributing to both Social Security and Medicare, just as you would be if you had a traditional W2 employer. In fact, you’re actually contributing more (the full 12.4%) since you don’t have an employer to cover half of these expenses on your behalf. This doesn’t mean that you’ll collect more in Social Security (unfortunately), but it does mean that you’ll still be entitled to collect on this when you retire.
If you haven’t factored Social Security income into your retirement needs, now would be a good time to do this. This can really help to take some of the burden and stress out of your retirement planning.