indy logo
Money fanned out in a hand

Some people decide to freelance because they prefer being their own boss. Others turn to this way of earning a living after losing other employment. There are those for whom freelancing is their full-time gig, while some freelance to earn extra money on the side. No matter how you ended up in the world of freelancing, you need to save for retirement. For a freelancer, the best retirement savings option is the Simplified Employee Pension (SEP) Individual Retirement Account (IRA). 

A SEP-IRA not only provides you with income once your working days are done, but during your career it allows you to take advantage of significant tax savings. 

The SEP-IRA is similar to a traditional IRA. If you operate your freelance business as a sole proprietor, partnership, or even a corporation, you can set up such a retirement account. 

Why You Can’t Afford Not to Save for Retirement

There are all sorts of advantages to freelancing. You have more control over your time and the projects you take on. Of course, there are disadvantages, too. Your work life may fluctuate between feast and famine. There are periods in which you are so busy that the rest of your life falls by the wayside, and other times in which you are scrambling for a gig. Depending on your field, your work is in demand at certain times of the year and may prove nonexistent in others. 

Too many freelancers fall into the trap of not saving for retirement. It is probably the last thing on your mind when you are starting out and struggling to pay bills, as well as keeping track of your quarterly tax payments. But time marches on, and you don’t want to find yourself nearing retirement age with no retirement savings on which to fall back. 

Successful freelancing requires discipline, as you are your own boss responsible for finding your own work. Use that discipline to put some money aside each month for retirement. Even if it is just a small amount, it’s a start. Increase the amount as your career grows. From tiny acorns grow huge oaks. 

SEP-IRAs vs. Traditional and Roth IRAs

Traditional or Roth IRAs are usually the first steps in retirement saving for freelancers. Both types of retirement plans allow you to contribute up to $6,000 of earned income annually. If you are over 50, you may put away an additional $1,000 as a catch-up contribution. 

Contributions to traditional IRAs, as with SEP-IRAs, are made with pre-tax dollars. These investments are tax-deferred until withdrawal, at which point they are taxed as ordinary income. Roth IRA contributions are funded with post-tax money. You cannot deduct Roth IRA contributions, but you do not pay tax on the monies later withdrawn. Unlike traditional and SEP-IRAs, there are no mandatory withdrawal requirements for Roth IRAs. There are annually adjusted income limits for Roth IRA contributions.  

The good news is that you can contribute to both a traditional or Roth IRA and a SEP-IRA, as long as you meet the income requirements. Whether or not you can deduct your traditional IRA contributions depends on various factors. If you are a part-time freelancer covered by an employer-sponsored retirement plan at work, you can make but not deduct traditional IRA contributions. That is not the case with an SEP-IRA. 

The beauty of a SEP-IRA is that you can contribute more towards your retirement and receive greater tax savings. 

SEP-IRA vs. Solo 401(k)

The solo 401(k) is another option for freelancers. Contribution limits and tax advantages are the same as for the SEP-IRA. However, if your freelance business includes any employees –with the exception of your spouse –you cannot open a solo 401(k). 

The key difference between the two retirement plans, though, involves paperwork. The administrative requirements for a solo 401(k) are far more burdensome than that of the SEP-IRA. In addition, once you have saved $250,000 in a solo 401(k), you must submit annual reports to the IRS. That is not the case with the SEP-IRA.

Both plans offer flexibility in that annual contributions are not required. While you should try to fund your retirement plan fully each year, freelancers know some years are leaner than others. 

Contribution Limits

The IRS permits you to put away as much as 20 percent of your annual net income from self-employment into an SEP-IRA. The contribution limit changes each year based on cost-of-living adjustments. For 2020, self-employed individuals may put away as much as $57,000, based on a net income limit of $285,000. For 2021, the self-employed may save up to $58,000, based on a net income limit of $290,000. 

An SEP-IRA functions in the same way as a traditional IRA, with the exception of contribution limits. The money contributed to the SEP-IRA grows tax-free until withdrawal. 

Withdrawing funds before you reach the age of 59 ½ results in penalties, and you must start withdrawing funds by the time you reach 72. That is true whether or not you have retired. 

The IRS changed the maximum age for withdrawing SEP-IRA funds in recent years, so anyone who turned 70 ½ before January 1, 2020 is required to start making such withdrawals. Keep in mind that failing to take Required Minimum Distributions (RMDs), the minimum amounts you must withdraw each year after reaching the mandatory age results in significant penalties. 

Unlike traditional IRAs, SEP-IRAs do not include catch-up contributions. 

Part-time Freelancers

Even if you are only a part-time freelancer, you can still open an SEP-IRA. That is true even if you are employed and contribute to an employer-sponsored 401(k) at work. You can still sock away up to 20 percent of your freelance net income in an SEP-IRA.  

Tax Advantages

Because SEP-IRA contributions are tax-deductible, your taxable adjusted gross income for the year is lowered. If you are a sole proprietor, just claim the SEP contribution on your IRS Form 1040. 

Setting Up a SEP-IRA

SEP-IRAs are indeed simple to set up. The IRS permits you to place your IRA funds in a wide variety of investments, with the exception of collectibles and insurance.  

Contact your bank, broker, mutual fund advisor or other qualified financial institution to get started. The deadline for making contributions is April 15 of the following tax year, although it can be later if you have filed for an extension of your tax return. 

The financial institution reports SEP-IRA contributions to the IRS on Form 5498 in the year in which they were made. You do not have to submit any paperwork on your own. No one got into freelancing so they could get bogged down doing paperwork, but it is a vital part of running your own business. Indy is here to help with many of those frustrating elements of freelancing, like invoicing, contracts, and other forms.

Share this article
Take the pain out of managing your freelance business
Indy — Easy-to-use tools to help you manage your independent business from contract creation to invoicing and getting paid, and everything in between.
Start for free
Learn more
Learn more