For the self-employed, pension planning can be a bit more complicated than for the rest of the population. They do not have the advantage of an employer-sponsored plan and an HR department where they can find advice and advice plan for retirement. However, that doesn’t mean self-employed people can’t have a comfortable retirement, or that they should work until they drop. With a little planning and creativity, the self-employed can save enough for a relaxed retirement full of fun, travel and well-deserved rest. Here are eleven tips to get you started.
Tip #1: Start saving for retirement as much and as early as possible
When we’re young, it’s hard to focus on long-term goals like retirement, and we tend to focus much more on our immediate needs. This includes things like buying a house or car, taking care of student debt, paying monthly bills, and more. If you’re a passionate entrepreneur running your own business, even things like housing and cars can come second in terms of priorities; you usually focus all your time and energy on business management and growthso retirement planning falls far behind.
However, if you want one comfortable retirement, the best time to start saving was yesterday; the next best time is today. At this point, what counts is not how much you save for retirement each month or year (we’ll cover that in a moment). What really matters is getting started.
But if you want to retire comfortably, you need to start saving as much as possible as early as possible. The sooner you start contributing to a retirement account, the more time your money has to grow through compound interest.
Why does this matter?
Most people don’t realize how much of an impact starting to save one, two or three years earlier can have on the size of your retirement nest egg.
Let’s run some simple numbers. Suppose you put $10,000 into a 401(k) when you’re 35. It will grow at an interest rate of 5-8%. If you take the lower 5% as interest, that $10,000 will have grown to $43,219 by the time you reach retirement age. If you wait a year and deposit the money at age 36, after 29 years, your balance will be $41,161 instead. That’s $2,058 less available to you for waiting just one year. Start saving when you turn 40 and you’ll end up with $33,864. That’s over $9,000 less, even though it’s the same $10,000 you started with.
Now imagine you not only save $10,000 total, but save roughly that amount each year, which is what most people saving for retirement do. If you run the numbers, the difference could be tens of thousands of dollars for waiting a couple of years instead of starting to save right away.
Tip #2: Even if you are your own boss, pay yourself a salary
Just because you don’t have an employer doesn’t mean you can’t pay yourself a salary. This is especially important if your business is doing well and you reinvest most of the profits back into the company and forget to withdraw some of them as income. When it comes to retirement planning, you need to know how much you earn each month you can budget accordingly and set aside enough money for the future. The best way to ensure this is to pay yourself a salary.
How much should you pay yourself?
The answer to this question depends on several factors. The most important are:
- Your current expenses
- How well is your business doing?
- The long-term financial goals for your company
- How much money will you need to live comfortably when you retire (more on this later).
Tip 3: Choose the right pension account
When you’re employed by someone else, there’s a good chance your employer will offer you access to a 401(k) retirement account. If they don’t, other possibilities is still available, like an IRA. For the self-employed, the options are a bit more limited, but there are still more retirement accounts you can choose between. The four most common are:
- One Participant 401(k): Also known as a Solo 401(k), this is perfect for the self-employed or business owners without employees. The contribution limit for 2022 is $20,500, but if you are over 50, you can contribute an additional $6,500 as a catch-up contribution.
- Simplified Individual Retirement Account for Employees, or SEP-IRA: This account is another tax-deferred retirement account available to small business owners and the self-employed. The contribution limit in 2022 is the lesser of 25% of your net self-employment income or $61,000.
- Savings Incentive Match Plan for the Employee Individual Retirement Account, or SIMPLE IRA: This retirement account is available to small business owners with 100 or fewer employees. The contribution limit in 2022 is $14,000, but if you are over 50, you can also contribute an additional $3,000 as a catch-up contribution to reach $17,000.
- Keogh Plan: This account is also known as a qualified retirement plan and is available to self-employed or unincorporated businesses.
Each of these retirement accounts has its pros and cons, so you need to do your research to find the best one for your specific situation. They all share one feature: they’re funded with pre-tax dollars, which means you’ll be able to defer paying taxes on them until you retire.
However, if you expect to reach a higher income bracket eventually, it may be wiser to choose a Roth IRA or a Roth 401(k). These accounts are funded with after-tax dollars, meaning you won’t get the tax break now, but will when you retire and start drawing from the account.
After making your decision, the most important thing is to start contributing to one of these accounts as soon as possible.
Tip #4: Estimate how much you need to save for a comfortable lifestyle during retirement
When you start saving for retirement, the most important thing is to start early and save as much as possible without disrupting your short-term plans and lifestyle. But eventually, you’ll want to start creating a real retirement plan. It means:
- Set clear and ambitious, yet achievable long-term goals and break them down into smaller, more manageable ones.
- Develop a clear strategy that will act as a road map to achieve these goals
- Trade according to that strategy and stick to it as closely as possible
- Conduct annual reviews to see how far you’ve come, what you’ve achieved, where you fell short, and what needs to change in the following year to get back on track or reach an even more ambitious goal.
When it comes to setting goals, these must be specific and measurable. Therefore, you need to define what you expect your retirement to be like so you can estimate how much income you will need to pay for that lifestyle without outliving your savings.
This estimate doesn’t have to be completely accurate, but rather an estimate that will help you put a figure on how much you should save each month of your income to enjoy the retirement you want.
Tip #5: Invest in a diversified mix of assets
When most people think of retirement, they envision sitting on a beach sipping cocktails or playing golf. But to make that dream a reality, you need to have enough money to cover your living expenses for 20, 30 or even 40 years.
The previous tip was about determining how much your living expenses amount to. But once you’ve run the numbers, you’ll likely find that your current income isn’t enough to save the amount you need each month. If that’s the case, don’t despair. You can dramatically reduce the amount of money you have to put aside each month if you manage to increase the return on your savings, even if it’s just a little.
This means you invest your savings, not just let them grow in a savings account. When it comes to investing, stocks and bonds are the two most common asset classes. But there are also other options such as property, equity fund, exchange-traded funds (ETFs), and even NFTs and crypto trading. The key is to invest in one diversified mix of assets to minimize the risk of losing money while giving yourself the chance to earn higher returns.
For example, let’s say you invest the same $10,000 as before when you’re 35, and you manage to get an average growth rate of 6% instead of 5%. In that case, instead of $43,219, you’ll have $57,435 when you retire. That’s a difference of over $14,000 for that extra 1% return, without saving a cent more than what you saved in the first place!
Tip #6: Ensure a minimum income level
No matter how much money you have saved for retirement, it is critical to have a plan in place to ensure you have a minimum level of income each month. There are several ways to do this, but the most common is to buy an annuity.
An annuity is a contract between you and an insurance company. In exchange for a lump sum payment, the insurance company agrees to make regular payments to you for a specified period of time or for the rest of your life. There are different types of annuities, and you can customize contracts to your heart’s content by adding contract riders.
Annuities are a way to protect your nest egg and ensure you have a minimum level of income each month, but they are not without their drawbacks. First, annuities are complex financial products, and understanding all the different features and benefits can be challenging. Additionally, annuities come with fees and commissions that can eat into your investment returns, something you need to watch out for.
What matters most anyway is that you set up a safety net to fall back on in retirement so you don’t have to worry about running out of money or outliving your savings.
Tip #7: Live a healthy lifestyle
No list of tips on preparing for old age would be complete without this important piece of advice. One of the best ways to reduce medical expenses in retirement is to live a healthy lifestyle when you’re young. This means eat healthy food, exercise regularly and have regular check-ups. Of course, this is not always easy, but it is worth it in the long run.
A healthy lifestyle will help you avoid costly medical expenses and help you feel better and enjoy retirement more. After all, what’s the point of saving for retirement if you can’t enjoy it?
So take care of yourself now and you’ll thank yourself later.
The bottom line
There is no one-size-fits-all answer to retirement planning, especially if you are self-employed. However, following these tips should get you off to a good start. Remember to invest in a mix of assets, ensure a minimum income level and live a healthy lifestyle. And most importantly, don’t wait until the last minute to start planning and saving for your golden years!
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