Top Retirement Planning Mistakes of the Self-Employed

Be the Boss of Your Future — As Well As Your Business

Top Retirement Planning Mistakes of the Self-Employed
June 12, 2014

If you are self-employed, you probably possess a high degree of independence and a strong initiative and work ethic. It takes a certain type of personality to strike out on your own and take full responsibility for your career and livelihood.

However, some self-employed individuals are so consumed in building their businesses that they neglect to plan for a day in the future when they will no longer be working. In fact, according to a survey conducted by the Freelancer’s Union, more than one out of four (27 percent) freelancers have not set aside any money yet for their future retirement.

Here are three common retirement planning mistakes made by self-employed individuals:

1. Not taking the initiative to get started. Many self-employed people never get out of the starting gate when it comes to saving for retirement. Why? Because it takes more effort to save for retirement when you are self-employed than it does when you work for a company that offers a 401(k) plan.

This starts with setting up a retirement plan — usually a SEP-IRA, SIMPLE IRA or Solo 401(k) — either at a bank or brokerage company or with an investment advisor. Then, you have to take the initiative to make regular contributions, or arrange for contributions to be automatically transferred into your plan from a checking or savings account.

Action: As the Nike slogan says, just do it. If you have not yet set up a retirement account, make a commitment to doing so right away. Then decide how much money you are comfortable contributing to the account each month and set up bank auto drafts so this is done automatically, without you having to think about it.

2. Not taking advantage of opportunities to maximize contributions. One of the biggest disadvantages self-employed individuals face when saving for retirement is not receiving an employer match. Some companies match contributions employees make to their 401(k) plans on a dollar-for-dollar basis, or maybe 50 cents or 25 cents on the dollar. This is a tremendous retirement saving advantage that obviously does not apply to self-employed individuals.

However, the federal government gives you an opportunity to more than make up for this by allowing you to sock away much more money for retirement than employees can save in a 401(k). In 2014, you can contribute up to $52,000, or 25 percent of your income (whichever is less) to a SEP-IRA. You also have the flexibility of contributing to a Roth IRA in addition to a SEP-IRA if you want to benefit from the after-tax advantages of Roth accounts while still getting a current tax deduction for your SEP-IRA contributions.

Action: Once you have set up a retirement account, contribute as much money as you can to it. The best vehicle for maxing out your contributions is a SEP-IRA. While you might not be comfortable committing to a large fixed monthly draft right away (see below), you can make extra contributions during months when your income is higher than normal. In addition, remember that you can make a lump-sum contribution all the way up until April 15 of next year for tax year 2014. Therefore, if you have a good year financially, put some of this excess cash into your SEP-IRA, which will also reduce your 2014 tax bill.

3. Investing inconsistently and too conservatively. Most self-employed entrepreneurs tend to be risk-takers, given the fact that they have eschewed the comforts of a corporate job with benefits and a guaranteed salary in favor of making it happen on their own. But ironically, they often tend to be overly conservative when it comes to investing their retirement savings.

This is probably due to the fact that there is an inherent amount of income uncertainty involved in being self-employed. Many self-employed individuals regularly experience “feast or famine” when it comes to their income: months when they collect more money than they know what to do with, followed by months when they might not collect enough money to pay their expenses.

Such uncertainty can make it hard to commit to a regular, disciplined approach to saving for retirement. Moreover, it can cause some self-employed individuals to take a more conservative approach to their retirement investments than they might if they had a steady paycheck coming in.

Action: As noted above, go ahead and arrange for monthly auto drafts from your bank account into your retirement account, even if you start out with a low amount. Remember that, unless you are approaching retirement soon, your retirement savings can probably be invested a little more aggressively, since you are investing with a long-term time horizon.

There are many benefits to being self-employed, but it can make saving for retirement more difficult. So be careful not to make these common self-employed retirement planning mistakes.

Let the free MoneyTips Retirement Planner help you calculate when you can retire without jeopardizing your lifestyle.

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