A staggering 36% of the US workforce were employed as freelancers in 2022, and this number is expected to grow to 50% by 2027. Out of 164.3 million people in the US labor force, 70.4 million have stated they worked as freelancers either full-time or as a part-time side hustle on top of their day jobs.
While most freelancers deliver work part-time as a side hustle, the freelance economy still accounts for $1.3 trillion in the US, an 8.3% increase from two years prior. The most promising part of the survey is that Gen-Z has the largest percentage of freelancers for their age group, indicating where the freelance economy is headed in the next few years. 50% of people ages 18 to 22 stated they have participated in freelance work, compared to only 26% of people who are ages 55+.
The growth in the freelance economy among young adults isn’t surprising. Freelancers have more freedom over their work schedules, and aren’t locked into a fixed salary. In addition, there’s also the opportunity to grow a personal brand and grow your clientele through social media, and most people see working for many employers as lower risk than working for a single employer.
However, one of the most common concerns with freelancers is that, unless they also have a full-time job with an employer that offers a 401k plan, they’re on their own when it comes to saving for their retirement.
That’s where Carry steps in. If you’re a freelancer, here are the best retirement plan options you can start on your own while self-employed. And guess what? They’re even better than what you can get as a salaried employee.
The best retirement plan options for freelancers
A surprisingly large number of freelancers do not know that there are retirement accounts that are specifically designed for business owners and self-employed people, like freelancers.
The two major ones are:
- Solo 401k
- SEP IRA
Before we dive into other retirement plans like a traditional or Roth IRA, let’s look closer at the solo 401k and SEP IRA and see if it’s the right fit for you.
We’ll cover the solo 401k first since it has many advantages over a SEP IRA.
With a regular corporate 401k, you need to work for an employer that sponsors a plan in order to participate. A solo 401k is essentially a 401k plan that can be opened by self-employed individuals. To be eligible, all you need is to have a business with no employees (besides your spouse).
Here are the formal eligibility rules:
- Have any form of business activity.
- Have no full-time W-2 employees that work over 1,000 hours per year, including part-time employees who have reached 21 years of age, and have worked over 500 hours per year for 3 consecutive 12-month periods.
The only exception to the no employees rule is your spouse. All business entities and income levels are eligible. You could be a sole proprietor making a few hundred dollars per month, or a multi-million dollar C-corp. The only strict rule is that you cannot have any employees in your business. If you do, your other option is the SEP IRA, which we’ll talk about in a little bit.
Also read: The Best Solo 401k Plans Compared
Before we continue, download the free Solo 401k Handbook: Everything you need to know about a solo 401k in a handy PDF format.
What’s so good about a solo 401k?
For easier understanding, let’s compare the solo 401k to a regular 401k that you might receive from an employer if you had a full-time day job.
- A regular 401k is set up by your employer and you could contribute up to $22,500 into your plan as an employee for 2023, or up to $30,000 if you’re at least 50 years of age or older. Your employer, while not obligated to do so, could choose to make matching contributions up to a certain amount on your behalf. After you contribute, you could invest your funds into a selection of mutual funds (usually 8 to 12 options) that your employer pre-selected when they set up the plan. With most 401k plans, your investment options are limited to just these pre-selected mutual funds.
- A solo 401k is set up by you and takes under 10 minutes to open an account. You do not need an employer to open the plan for you since you’re your own employer. As the owner of your own business, you get to contribute as both the employer and the employee, which increases your contribution limit to $66,000 for 2023, or up to $73,500 if you’re at least 50 years of age. After you contribute, you could invest the funds in virtually any asset class you like, including individual stocks, ETFs, mutual funds, bonds, real estate, crypto, and even write checks into startups as an angel investor.
A few things not mentioned above is that a 401k plan usually does not come with a Roth account, which allows you to contribute after-tax income and take tax-free withdrawals in retirement. With a solo 401k plan, you could contribute up to $22,500 ($30,000 if age 50+) as employee Roth contributions, and you even have the option to do a mega backdoor solo 401k conversion and contribute up to $66,000 ($73,500 if age 50+) entirely into your Roth solo 401k account.
A SEP IRA has similar features to a solo 401k, but lets you have employees in your business.
However, a few key features are missing.
- A solo 401k has a Roth option, a SEP IRA does not. A Roth solo 401k works similarly to a Roth IRA. You contribute with after-tax income, but your withdrawals in retirement are completely tax-free.
- A solo 401k lets you invest in almost asset class, including alternative assets like real estate and crypto. A SEP IRA only allows investments into traditional assets like stocks and ETFs.
- A solo 401k has catch-up contributions, a SEP IRA does not. The solo 401k allows people age 50+ to contribute an extra $7,500 into their plans for 2023. They could contribute up to $73,500 instead of $66,000. A SEP IRA has a contribution limit of $66,000 regardless of your age.
- A solo 401k has a loan option, a SEP IRA does not. You can borrow up to 50% of your plan value, up to a maximum of $50,000. You have 5 years to pay it back and can use the funds for whatever you want. A SEP IRA does not have the option to take a loan.
And lastly, there’s one major difference on contribution rules with a SEP IRA.
With a solo 401k, you can contribute as both the employee and employer. And you can pick and choose which type of contribution to make, and for how much. This gives you major flexibility in adjusting your own tax benefits and savings, and also allows you to max out contributions with a lower business income.
With a SEP IRA, you can only make contributions as the employer. Employees cannot make contributions directly. In addition, if you have any employees, you’re also required to equally match your percentage of employer contributions into employees’ accounts. For instance, if you contribute 8% of your compensation into your SEP IRA, you must also contribute 8% of every eligible employee’s compensation into their SEP IRAs. While contributions are made with pre-tax income and are tax deductible, if you have a lot of employees, matching contributions can get expensive.
Roth IRA and traditional IRA
A solo 401k and SEP IRA are both retirement accounts designed specifically for business owners. To qualify, you need business income or have earned money from a self-employment.
A Roth IRA and traditional IRA are open to anybody with earned income, whether it be from a job, one-off gig, or business. The contribution limits are much lower than a solo 401k and SEP IRA, but you can make contributions to an IRA even if you have a solo 401k or SEP IRA.
We grouped the Roth and traditional IRA together because they’re sister products to one another. The only difference is how contributions are made, and how they’re taxed.
Here’s what that means:
- Traditional IRA: Contributions are made with pre-tax income and deductible from your taxable income. However, withdrawals in retirement are taxed as regular income.
- Roth IRA: Contributions are made with after-tax income and you get no tax deductions or any other tax breaks when you contribute. However, withdrawals in retirement are completely tax-free. As stated earlier, this works similarly to a Roth solo 401k.
For 2023, you can contribute up to $6,500 into an IRA, or up to $7,500 if you’re at least 50 years of age. However, you can’t contribute $6,500 into a traditional IRA and contribute another $6,500 into a Roth IRA. Contribution limits are aggregated between all of your IRAs, meaning the total contributions across all of your IRAs cannot exceed the $6,500 ($7,500 if age 50+) contribution limit for 2023.
Similar to a SEP IRA, you can typically only invest your IRA funds in traditional assets like stocks, bonds, mutual funds, and ETFs. However, if you want to invest in alternative assets like crypto and real estate, there is also the option to a get a self-directed IRA with a specialized plan provider. These are more expense to own and manage, but opens the door to more investment options.
Should freelancers open a business retirement plan?
For most cases, freelancers will benefit with having a business retirement plan, especially a solo 401k. With the flexibility of a solo 401k, you get to configure your contribution amounts and types to get the tax breaks you need for that year.
For example, if you made too much business income and want to reduce your taxes, you can potentially reduce your taxable income by $66,000, or up to $73,500 if you’re 50 years of age or older. Or, you could choose to pay taxes upfront, and contribute a large portion of it into your Roth solo 401k and invest it in alternative assets.
You also get to choose where you want to get a tax break, whether it’s on the business income side or personal income side. Contributions aren’t mandatory each year, and maintenance of the plan requires minimal work each year. If you run a freelancing business and have zero employees, a solo 401k can help reduce your taxes and build wealth.
Also read: Solo 401k Vs SEP IRA
Can you contribute to multiple retirement plans at once?
Yes, you can contribute to a traditional and/or Roth IRA while contributing to a SEP IRA and solo 401k in the same tax year.
However, it’s typically not allowed to have both a solo 401k and SEP IRA for one business entity.
If you’re trying to decide between a solo 401k and SEP IRA, the decision should come down to: If you have no employees, get a solo 401k. If you’re not eligible for a solo 401k because you have employees, get a SEP IRA. Of course, speak with a financial advisor or your accountant first about your specific situation before you open any accounts.
If you want to learn more, download the Solo 401k Handbook below: