self directed 401k

Freelancer Retirement Plan: The Self Directed 401k

Freelancers, it’s time to talk about retirement. Yes, even though the subject of a self-directed 401k gives you stress dreams.

The good news for you is that you’re not on your own here – freelancers now make up about 35% of the U.S. workforce. Resources for taxes, insurance and, yes, retirement has never been better. There’s even a union.

It’s like your mom always told you: the best time to start saving for retirement is yesterday. Here’s your getting started guide to a self-directed 401k.

Types of Self Directed 401K

No, it’s not a jar under your mattress. It’s not an extra savings account, either.

There are a lot of benefits to being self-employed. Want a day off? Take a day off.

There’s good money in it, too. Almost half of the entrepreneurs in the U.S. make $50,000 annually.

However, slightly more than half are worried about the lack of an employer-sponsored retirement plan.

They’re right to be concerned. Freelancers are no more equipped than their corporate counterparts to save for retirement – the difference is that no one’s doing it for them.

Why Aren’t Freelancers Saving for Retirement?

The short answer? To paraphrase the Black Keys, you got bills to pay, you got mouths to feed and ain’t nothing in this world for free.

Long answer? Two primary reasons:

  1. Unpredictable income
  2. Unfavorable retirement plans

That’s where a self-directed 401k (and doing your homework) can save you. Here are the three most common types you’ll encounter.

Solo 401Ks

The name explains the game.

Solo 401ks are popular among the self-employed. Why? Your only requirements for eligibility are some form of self-employment activity and a lack of employees.

That said, you’ll need to find a financial company that offers the plans – and access to mutual funds.


Technically, these plans have less paperwork.

Celebrate good times, right? Especially because you can put in higher contributions than a solo 401k.

That said, if you’re looking at SEP-IRAs instead of a solo 401k on account of employees, be aware that it will cost you more – you’ll have to make equal percentage contributions for every one of your eligible employees.

Rollover IRA

Rollover IRAs are another popular type of self-directed 401k. Mostly because they’re not really all that self-directed.

Real talk. You probably worked for someone else before you came to the dark side. That someone else had a retirement plan you enrolled in.

The assets from that plan are still yours. The simplest way to manage them is to transfer them to a rollover IRA, which allows you to transfer all assets from a former employer’s plan (including a 401k).

Just don’t fall victim to the common IRA mistakes.

How Solo 401ks Work

The keyword here is solo.

Basically? A solo 401k plan is for a self-employed individual.

The Basics

As a self-directed 401k, solo 401ks work on a similar premise as other 401k plans. However, since it’s just you, it’s different from large-employer 401k plans in a few key ways:

  • You act as both employer and employee on the plan
  • It’s only available to you and your spouse, not any employees
  • You can contribute more generously than you would under a typical employer 401k plan
  • You can set one up as a freelancer or independent contractor

Think of it this way. If your company staff consists of me, myself and I, then a solo 401k can cover you. If anyone else works for you, this won’t cover them.

However, as plans go, this is a reasonably simple one. You’re free to choose your investment trustee and broker (which is actually more like a self-directed IRA.)

That’s good news for you – it means far lower fees and unlimited investments. Go make it rain.

Solo Contribution Limits

Don’t drive yourself nuts. There are no crazy loopholes or hoops you have to jump through.

Under a solo 401k plan, you’re the employee. That means your contribution limits under a solo 401k are exactly the same as any other 401k.

You can contribute up to 100% of your salary or the contribution limit, whichever is higher. As of 2017, the limit is $18,000 of your salary or up to $24,000 for those who are 50 and up.

Don’t get excited yet. Because you have to remember that under this self-directed 401k, you’re also the employer.

From this side of things, you can contribute up to 25% of your net income.

Contribution Deadline

Oh, and one other thing about this variety of self-directed 401k?

Your contributions have to occur by the end of the calendar. Do not pass go. Do not collect $300.

Note: that’s the calendar year, not the fiscal year. All your contributions have to be in the bank by December 31st in order to be deductible for that tax year.

How SEP-IRAs Work

Is your head spinning yet?

Great! Moving along to SEP-IRAs. Also known as Simplified Employee Pension IRAs.

Remember how a solo 401k is will cover me, myself and I (and my spouse)? That’s not how this works. Also, despite the fact that it’s being classed under self-directed 401k here, it’s not actually a 401k.

Thus the term IRA.

The Basics

In one sentence, SEP-IRAs are a type of traditional IRA. Except it’s for the self-employed or small business owners. So a bit less traditional.

For one thing, these IRAs can receive employer contributions. Actually, there’s also a higher annual contribution limit.

Here’s the trick to SEP-IRAs. Unlike a solo 401k, which is really for those who work for themselves and on their own, SEP-IRAs are designed for a business owner in an individual LLC, partnership, or an S- or C- corporation.

Which makes sense when you remember that SEP-IRAs include an employee under their umbrella (which is why it’s more expensive for the employer).

How To Know If a SEP-IRA is Right For You

You can start by asking yourself a few questions.

For starters: do you want to be the sole contributor, or do you want to have employees contribute? A SEP-IRA will only allow contributions from employers.

Also: can you afford to contribute an equal percentage for every eligible employee? That’s also a requirement.

Contributions to a SEP-IRA

Here’s the truth about contributions. Technically, you don’t have to contribute every month.

You should though. Especially if you’re a small business owner who may not be able to afford a lump sum contribution.

The beauty of SEP-IRAs is that they can also be opened and funded until the year ends. As a tax planning technique, you can also hold off contributing until right before you file your taxes so you know how much to contribute.

Where contribution limits are concerned, SEP-IRAs are a similar story to solo 401ks. The maximum allowed contribution amount to a SEP-IRA as of 2017 is 25% of your income, or $54,000, whichever is higher.

Notice something? Yup. That’s far higher than a standard IRA. Benefits of being a freelancer.

Tax Advantages of an IRA

There’s also the tax advantages of using an IRA rather than a solo 401k.

Where taxes are involved, a SEP-IRA is treated like a traditional IRA. Transfer and rollover rules are all the same under a SEP-IRA, and like other IRAs, an employer receives a tax deduction for the amount contributed.

However, like a traditional IRA, you’ll also be paying taxes when you withdraw it since you won’t be paying taxes along the way.

Other Retirement Tips for Freelancers

Like your mom always told you when you got your allowance: don’t spend it all in one place.

The same story applies to saving. It’s to your benefit to have a few savings options on hand. Here are two other savings methods you should have to supplement your self-directed 401k.

Emergency Savings

If you don’t have anything else as a freelancer (first of all: shame on you) then you should have an emergency savings fund.

This should cover at least three to six months of essential expenses, including housing, groceries, transportation, utilities, etc.

If you have more (like, say, a year’s worth) sitting in a bank account accumulating functionally zero interest, then you should consider looking for a higher-interest account. Here’s what to look for.

Curveball Funds

Sometimes, life happens. As in, sometimes life throws you curveballs and you land flat on your back and foggy about how you wound up there.

That’s what a curveball fund is for.

This isn’t your emergency savings. This is a smaller savings account meant to save you in the event of life’s unexpected gifts, like your car breaking down.

You know, things that feel like emergencies but aren’t quite as dire as, say, getting hospitalized or having zero income.

Since these are smaller emergencies, you should ideally keep between $1,000 to $2,000 in the fund. If you don’t have that change to put in the bank right away, then make a habit of putting in $100 to $200 (or whatever you can afford) until you’ve got a comfortably established curveball fund.

Save Your Dollars Smarter

Life gives you lemons. Or curveballs, depending on your metaphor of choice. That’s why saving smart and saving early matters so much. Click for more advice on how to do just that.

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