How do I set up a retirement plan for my freelance business?

October 1, 2022

When you're self-employed, there are a few different retirement options available to you. The most common are:

  • Solo 401(k)
  • SEP IRA
  • SIMPLE IRA
  • Traditional (or Roth) IRA

This post breaks down each account in detail, but here's a quick overview of each to help determine which may be the right fit:

Solo 401(k) - $61,000 annual contribution limits, cannot have employees (other than spouse), contributions to Traditional Solo 401(k) help reduce taxes in current year, contributions to a Roth 401(k) will give you tax-free income at retirement & no tax breaks in current year

If you have employees, you could set up a full 401(k) plan for your freelance business that allows for additional members.

SEP IRA - best for solo or few-employee businesses, $61,000 annual contribution limits (or 25% of earnings, whichever is less), contributions can help reduce taxes in the current year

SIMPLE IRA - $14,000 annual contribution limits, if you have employees you must contribute to all accounts, investments grow tax-deferred

Traditional or Roth IRA - $6,000 annual contributions limits in 2022, Traditional IRAs give you a tax break in the current year when you contribute, and Roth IRAs give you tax-free income at retirement & no tax break in the current year. If you earn more than $78,000 and you're a single-filer, you cannot deduct Traditional IRA contributions

Defined Benefit Plan - While they're much more complex and expensive to set up, defined benefit plans can let high-earning freelancers contribute more than $100,000 to a tax-deferred retirement account. Read more about defined benefit plans here.

My pick - Solo 401(k) - It lets you contribute more than other accounts, it provides a lot of flexibility with investment selection and tax type (Traditional and Roth options), you can take loans against your portfolio, and you can take advantage of the tax benefits

Where to set up

If you decide to go with a Solo 401(k), two of the best places to use are Vanguard or Solo401k by Nabers Group. Vanguard has lower fees, but the Nabers Group option has more investment options. You can also take out loans against your portfolio's value.

If you have employees and want to set up a 401(k) plan, I recommend Guideline. The platform is super user-friendly and it's one of the most affordable options out there. When looking into different options, be sure to check their monthly or annual maintenance/account fees.

The most traditional top choices are Vanguard and Fidelity. On both of those links, you'll find details about each of the accounts we mentioned above.

To get an account opened, you'll have to submit an application that includes information about you and your business so that they can verify ownership. Once approved, you then have a functioning retirement account 💸

Picking investments

After you choose your account type and get it opened, then you can choose your investments. There are unlimited investment strategies and approaches out there, but I like to take a passive, long-term approach. You may decide to invest in the stocks of individual companies you believe in or you may want to take a more passive approach - which means you could go with a few broad-market ETFs (i.e. bundles of different stocks).

So for example, a classic set of investments is a 3-fund portfolio.

The idea is to pick a group of simple, low-cost ETFs or mutual funds that give you plenty of diversification. Here's an example using Vanguard funds:

  • Vanguard Total Stock Market Index Fund (VTSAX)
  • Vanguard Total International Stock Index Fund (VTIAX)
  • Vanguard Total Bond Market Fund (VBTLX)

You may choose to go 50% total stock market, 25% international, 25% bonds. Or depending on your risk tolerance, maybe you pick some individual stocks with 25% of your money and stick with a total stock market and international index with the other 75%. There's no right way to go about it but when it comes down to it, simpler is typically better (especially if you don't have a desire to frequently research and check investments).

Read: How to Create a Three-Fund Portfolio

Also read: 3 Legitimate Investment Managers Share Their Portfolios & Investment Selections

Monitoring

You could make it a regular practice to check your account monthly or quarterly so that it's not always top of mind, but you have a decent understanding of how it's performing. I'd set a recurring calendar event for whatever frequency you decide on.

An important strategy to keep in mind is rebalancing. You may not have to do it often if you keep a simple investment selection, but rebalancing is the process of buying & selling investments to keep them at desired levels. For example, in the Vanguard portfolio above, we outlined a 50/25/25 allocation. If the stock market was performing well in America but bonds and international stocks were down, your portfolio may end up being too heavily weighted towards U.S. stocks (75% for example). You'd then want to rebalance your portfolio and bring it back to a 50%/25%/25% allocation.

Tax-loss harvesting is another strategy where you intentionally sell some investments at a loss to offset the gains from other investments.

These strategies can be difficult to implement without experience, but there are a lot of great resources & walkthroughs out there. Overall, if you keep your investment selection simple and take a long-term approach, investing should be a simple activity that primarily operates in the background.

You don't need to check your portfolio every day and you don't have to react to every breaking news story. You can automate your contributions, set your investment selections, and sit back while time and compound returns do their thing.

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