The idea of retiring spooks out most freelancers. A lot of us do not even think about it when we are in our prime. We have to accept the limitations that age imposes upon us and start saving for the future in a systematic way. Here’s some help.
As a full-time freelancer you do not have access to employer co-sponsored retirement plans like the 401(k). It makes sense because you chose to be self-employed. Having a retirement plan is even more important for you and you have to start now whatever your age is. You do not want to start planning your retirement when you are 50, it’ll be a very stressfull game of catch up for you. This article will give you some very precise directions as to your [personal finance. This is not an exhaustive course on personal finance, neither will these tips replace the need for having an accountant. Nevertheless, by the end you’ll have a pretty solid foundation to start building knowledge base.
1. Have a cushion to lean on
As a freelancer, you can be the best in your field and yet your income is unpredictable. You may lose a primary client without any fault on your part. It may take you 2,3,4 months to replace the source of income. While it is unlikely that you will lose all your sources of income at the same time, it is likely that you lose the client you depend the most upon. For such scenarios, you need to make a cushion-fund with at least 3 and ideally 12 months of necessary expenses.
So, let us say, you make a profit of $5000 in a month and spend $3000 on your household expenses, bills, education for your children and so on. That means your cushion should be worth at least $9000 and ideally $36000. As a freelancer, this is the first saving you should worry about before even thinking about retirement and other goals. Put whatever you can spare every month into this emergency account until you have reached your goal. Use this fund only for necessities when you face an unprecedented financial rough patch.
2. Start an Individual Retirement Account or IRA
IRAs are a decent option for you to start saving for your retirement from an early age. You have two primary IRA options, the traditional IRA and Roth IRA. In fact, you can avail both. This is how it works, you can invest a maximum of $5500 per year in a traditional IRA. You can deduct this amount from your taxable income. Upon retirement, you can withdraw the invested amount which will then be taxable.
It is a great option if you expect your income to go down as you get older. Because the taxe you’ll be paying while withdrawing these funds will be based on your tax bracket at that point in time.
However, if you think you’ll work way into your golden years and your income then will be significantly higher than your income now, you should consider a Roth IRA. With this type of IRA you do not get a tax deduction on the invested amount. But you will be able to withdraw your money without paying any taxes on it.
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3. Open an SEP IRA
If you are earning a fair amount of money from your freelance ventures and you want to stack a bigger chunk of your income in IRAs, a simplified employee pension IRA or SEP IRA is a great option for you. It allows you to invest up to 25% of your yearly income or $66000 whichever is lesser. You need to be a business owner or self employed to avail of this IRA option. Just like the traditional IRA, the SEP IRA is also tax deductible. However, you need to pay taxes when you withdraw the funds.
4. Open a brokerage account
Opening a brokerage account lets you invest in stocks, mutual funds, bonds, and other forms of securities without any upper limit. You pay taxes only on the capital gains you make when you withdraw the funds. Investing systematically in mutual funds is a great way to save and increase your money. You will need relatively higher risk tolerance to use this option. Diversification of your money is key to securing a sizable and secure income post-retirement.
5. Keep the quarterly taxes aside
Keep meticulous records of your taxable income and pay estimated tax amounts quarterly to avoid paying the 3% penalty. Keep track of all your investments to effectively file for the tax returns. It’s important that you keep the tax amount aside before planning expenses or investments.
Conclusion
You can’t put enough stress on the importance of starting early in terms of saving for retirement or gaining financial independence. Do not wait so long that you have to play catch up. Start early, even if with a small amount, make saving a habit, invest wisely to remain in lower tax brackets and you’ll be good.
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