How Much Can You Withdraw in Retirement?

Posted On March 24, 2015 By Scott Stratton, CFP(R), CFA In Retirement Planning /

With corporate pensions declining in use, retirees are increasingly dependent on withdrawals from their 401(k)s, IRAs, and investment accounts. The challenge facing investors is how to plan these withdrawals and not run out of money even though we don’t know how long we will live or what returns we will receive in the market on our portfolio.

Pensions and Social Security provide a consistent source of income that you cannot outlive. When I run Monte Carlo simulations – computer generated outcomes testing thousands of possible scenarios – we find that the larger the percentage of monthly needs that are met from guaranteed sources, the lower chance the investor will run out of money due to poor market performance from their portfolio.

If you do have a pension, it is very important to consider all angles when deciding between a lump sum payout and participating in the pension for the rest of your life. It is not a given that you will be able to outperform the pension payments, especially if you are healthy and have a long life expectancy.

The most obvious way to avoid running out of money (called longevity risk by financial planners) would be to annuitize some portion of your portfolio through the purchase of an immediate annuity from an insurance company. While that would work, and is essentially the same as having a pension, very few people do this. You’d be giving up all control of your assets and reducing any inheritance for your beneficiaries. With today’s low interest rates, you’d probably be less than thrilled with the return. For example, a 65-year old male who places $100,000 in a single life immediate annuity today would receive $542 a month.

The problem with annuitization, besides giving up your principal and not leaving anything for your heirs, is that it doesn’t allow for any increase in expenditures to account for inflation. There are three approaches we might use to structure a withdrawal program for a retiree.

1) Assume a fixed inflation rate. In most retirement planning calculators, projected withdrawals are increased by inflation to maintain the same standard of living. After all, who doesn’t want to keep their standard of living? The result of this approach is that the initial withdrawal rate then must be pretty low. 20 years ago, the work of William Bengen established the “4% rule” which found that a withdrawal rate of 4% would fund a 30-year retirement under most market conditions.

On a $1 million portfolio, 4% is $40,000 a year. But that is just the first year. With 3% inflation, we’d plan on $41,200 in year two, and $42,436 in year three. After 24 years, withdrawals would double to $80,000. The 4% rule is not the same as putting your money in a 4% bond; it’s the inflation which requires starting with a low initial rate.

While we should plan for inflation in retirement, this method is perhaps too rigid in its assumptions. If a portfolio is struggling, we’re not going to continue to increase withdrawals by 3% and spend the portfolio to zero. We have the ability to respond and make adjustments as needed.

2) Take a flexible withdrawal strategy. We may be able to start with a slightly higher initial withdrawal rate if we have some flexibility under what circumstances we could increase future withdrawals. In my book, Your Last 5 Years: Making the Transition From Work to Retirement, I suggest using a 4% withdrawal rate if you retire in your 50’s, a 5% rate if you start in your 60’s, and 6% if retiring in your 70’s. I would not increase annual withdrawals for inflation unless your remaining principal has grown and your withdrawal rate does not exceed the original 4, 5, or 6%.

This doesn’t guarantee lifetime income under all circumstances, but it does give a higher starting rate, since we eliminate increases for inflation if the portfolio is shrinking. Under some circumstances, it may even be prudent to reduce withdrawals to below the initial withdrawal amount temporarily. That’s where having other sources of guaranteed income can help provide additional flexibility with your planning.

3) Use an actuarial method. This means basing your withdrawals on life expectancy. Required Minimum Distributions (RMDs) are a classic example of an actuarial strategy: you take your account value and divide by the number of years of life expectancy remaining. If your life expectancy is 25 years, we take 1/25, or 4%. The next year, the percentage will increase. By the time someone is in their 90’s, their life expectancy will be say three years, suggesting a 33% withdrawal rate, which may work, but obviously will not be sustainable. However, the more practical problem with using the RMD approach is that many people aren’t able to cut their spending by 20% if their portfolio is down by 20% that year. So even though it has a sound principle for increasing withdrawals, the withdrawal amounts still require flexibility based on market results.

But there are other ways to use the actuarial concept, and even my approach of different rates at different retirement ages is based on life expectancy. There’s no single method that will work in all circumstances, but my preference is to take a flexible strategy. But this does mean being willing to reduce spending, and forgo or even cut back inflation increases, if market conditions are weak.

We have a number of different tools available to evaluate these choices throughout retirement, but the other key factor in the equation is asset allocation. Bengen found that his 4% rule worked with equity allocations between 50% and 75%. Below 50% equities, the portfolio struggles to keep up with inflation and withdrawals become more likely to deplete the assets in the 30-year period. Above 75% equities, the portfolio volatility increases and rebalancing benefits decrease, increasing the number of periods when the 4% strategy would have failed.

When sorting through your options, you need candid and informed advice about what will work and under what circumstances it would not work. We hope for the best, but still have a plan for contingencies if the market doesn’t cooperate as we’d like. We will be able to consider all our options as the years go by and be proactive about making adjustments and corrections to stay on course. For any investor planning for a 30-year retirement, it’s not a matter of if the market will have a correction, but when. It’s better to have discussed how we will handle that situation in advance, rather than waiting until the heat of the moment.

Retiring Soon? How to Handle Market Corrections.

Posted On March 2, 2015 By Admin In Retirement Planning /

I was recently asked “How would you protect a soon to be retired investor against the inevitable market correction that will occur in the next couple of years?” It’s a great question and I think it’s very important that investors understand the risks they take when investing. Having not had a significant correction in six years, we may be well overdue. Of course, some forecasters have been calling for a correction for a couple of years, and yet the S&P 500 was up 13% last year and 32% the year before. That’s the problem with trying to time the market – it’s not possible to predict the future and it’s too easy to miss good returns by sitting on the sidelines. So, how should investors position their money if they’re a couple years from retirement?

The first thing is to frame the investment portfolio in a broader context. Someone who is four years from retirement does not have a four-year time horizon, but more likely, a 30-year time horizon, so we want to focus on finding the best solution for the whole 30-year period. That means we have to balance the desire for short-term safety with the long-term need to keep up with inflation and not run out of money. While retirement may be a one-time event, retirement planning is an on-going process.

In addition to withdrawals from accounts, retirees will have other, guaranteed, sources of income, such as Social Security, Pensions, or Annuity payments. These may cover a significant amount of fixed expenses, which allows the investment portfolio to be used in a somewhat discretionary manner during retirement. With corrections occurring every 5 to 6 years on average, a retiree could experience five or more corrections over the course of a 30-year retirement.

The reality is that we have to be willing to accept some level of volatility in a portfolio in exchange for the potential for a higher long-term rate of return. We start with a risk tolerance questionnaire to get to know each client and help select a target asset allocation that will be the most likely to accomplish their financial objectives with the least amount of risk. There’s no magic bullet to give investors a great return and no risk, so it truly is a decision of selecting an acceptable level of risk that will fulfill their planning needs. Almost everyone needs to have a mix of safer assets and assets which offer an opportunity for higher long-term growth. Some of my clients have 50 percent or more in bonds, and that may work for their situation.

With the portfolio construction, I am very focused on creating a strong risk/return profile for each of my models. We diversify broadly to reduce correlation of assets and systematically rebalance each portfolio on an annual basis. Rebalancing provides a discipline of selling assets which have run up and buying assets which are cheaper. We can eliminate some types of risk altogether, including company-specific risks (by owning the whole market rather than a handful of individual stocks), and manager risks. We know that typically 65-80% of equity managers under perform their benchmark over five years, but since we don’t know which managers outperform in advance, choosing managers is simply not a good bet to be making. That’s why we use index funds rather than selecting “five star” fund managers for our core holdings – it puts the odds in your favor.

We buy Low Volatility ETFs for some client portfolios, and I think many investors would be interested in learning about ways to reduce market fluctuations. Low Volatility funds select a basket of the least risky stocks from a larger index. They’re designed to offer a return similar to traditional indexes over time, but with a noticeably lower standard deviation of returns. They’re fairly new strategy (available the last three years or so), but I think are one of the more compelling ideas in portfolio management today. Read more here: http://www.ishares.com/us/strategies/manage-volatility

Lastly, when working with a new client, we can dollar cost average over six months, so if we do have a pullback in the fall (as we did last October), we would have cash to put to work. The key is that even someone who is planning on retiring in the next couple of years needs to have a clear plan that addresses both their accumulation needs and a retirement income strategy. That’s our focus at Good Life Wealth Management and we’d be happy to meet with you and discuss how to accomplish your retirement goals.

What Not to Do With Your 401(k) in 2015

Posted On December 23, 2014 By Admin In Retirement Planning /

In a recent article, “Are You Smarter Than a Fifth Grader? You Better Be If You Want to Participate in a 401(k)”, I mentioned that a basic financial education might help prevent investors from making common mistakes with their 401(k) accounts. What are those mistakes? Here are the top five blunders to avoid with your 401(k) in 2015 and a preferred outcome for each situation.

1) Using your 401(k) as an emergency fund. It’s all too common for participants to cash out their accounts if they have an emergency or when they leave a job. Withdrawals before age 59 1/2 are subject to a 10% penalty and ordinary income tax, in which case you end up losing 30 to 50 cents of every dollar in your account to the IRS. Preferred Outcome: make sure you have sufficient emergency funds before starting a 401(k). When changing jobs, roll your 401(k) to the new 401(k) or an IRA, or leave it at the old plan, if possible.

2) Contributing only up to the company match. Getting every matching dollar available is a smart idea, but a significant number of participants contribute only up to this level. Just because the company matches 4%, doesn’t mean 4% will be enough to generate the amount of money you need to retire! Preferred Outcome: aim to save 10-15% of your salary for retirement. If you can, contribute the maximum to your 401(k), which is $18,000 for 2015, or $24,000 if over age 50.

3) Giving up when the market is down. No one likes to open their 401(k) statement and see that the account is worth thousands of dollars less than the previous month. Unfortunately, if you move into a money market fund, or worse, stop contributing, you may actually be making things worse. Preferred Outcome: focus on your long-term goals and not short-term fluctuations. When the market is down, consider it an opportunity to buy shares on sale.

4) Not Being Diversified. Although it’s tempting to pick the fund with the best 1-year return, there’s no guarantee that particular fund will continue to outperform. (In fact, it’s quite unlikely.) Other participants put their 401(k) into a money market fund, which is almost certainly going to be a poor choice over 10 or more years. Your best bet is to be thoroughly diversified in an allocation appropriate for your age and risk tolerance. Preferred Outcome: develop a target asset allocation; if in doubt, use a target date fund to make these decisions for you.

5) Taking a 401(k) Loan. While taking a 401(k) loan is an option, I rarely meet participants with significant balances who take loans. You have to pay back loans with cash, not salary deferrals, which means that many participants stop their contributions in order to pay back the loan. Any amount not paid back on time is considered a distribution, subject to taxes and the 10% penalty, if under age 59 1/2. Additionally, if you change jobs or are laid off, you will have to pay back the loan within 60 days. Preferred Outcome: don’t sabotage your retirement by taking a loan. Consider other options first.

At Good Life Wealth Management, we know how important 401(k) plans are to your retirement planning. And that’s why all our financial plans include detailed recommendations for each of your accounts.

Are Your Retirement Expectations Realistic?

Posted On December 8, 2014 By Scott Stratton, CFP(R), CFA In Retirement Planning /

While many individuals have very realistic ideas about retirement, I find that some people may be significantly overestimating their preparedness for funding their financial needs. Here are three specific mistakes which can hurt your chance of success in retirement, and a realistic solution for each issue.

Mistake #1: Thinking you can live on a small fraction of your pre-retirement income.
Occasionally, I’ll meet someone who is currently making $100,000, but who thinks that they will need to spend only $40,000 a year in retirement to maintain their current lifestyle. On a closer look, they’re saving about $15,000 today so they are really living on about $85,000 a year. This is a key problem with creating a retirement budget: when we add up projected expenditures, it is very easy to underestimate how much we need because we often forget about unplanned bills like home and auto repairs, or medical expenses. And don’t forget about taxes! Taxes do not go away in retirement, either.

Realistic Solution: Even though some expenses will be lower in retirement, most retirees find that they need 75-90% of their pre-retirement income to maintain the same lifestyle.

Mistake #2: Taking too high of a withdrawal rate.
20 years ago, William Bengen published a paper that concluded that 4%, adjusted for inflation, was a safe withdrawal rate for a retiree. While this topic has been one of the most discussed and researched areas in retirement planning, most financial planners today remain in agreement that 4%, or very close to 4%, is the safe withdrawal rate. However, many individuals who have a million dollar portfolio think that they might be able to take out $60,000, $70,000, or more a year, especially when the market is performing well.

There are two important reasons why it’s prudent to use a more conservative 4% rate. The first is market volatility. The market is unpredictable, so we have to create a withdrawal strategy which will not excessively deplete the portfolio in the event that we have large drop, or worse, a several year bear market at the beginning of a 30-year retirement. The second reason is inflation. We need to have growth in the portfolio to allow for the increased cost of living, including the likelihood of increased medical costs. At just 3% inflation, $40,000 in expenses will double to $80,000 in 24 years. And with today’s increased longevity, many couples who retire in their early 60’s will need to plan for 30 years or more of inflation in retirement.

Realistic Solution: At a 4% withdrawal rate, your retirement finish line requires having a portfolio of 25 times the amount you will need to withdraw in the first year.

Mistake #3: Assuming that you will keep working.
Some people plan to keep working into their 70’s or don’t want to retire at all. They love their work and can’t imagine that there would ever be a day when they are not going to be working. They plan to “die with their boots on”, which in their eyes, makes retirement planning irrelevant.

Unfortunately, there are a number of problems with this line of thinking. The Employee Benefits Research Institute 2014 Retirement Confidence Survey found a significant gap between when people planned to retire and when they actually did retire. Only 9% of workers surveyed plan to retire before age 60, but 35% actually retired before this age. 18% planned to retire between 60 and 64, versus 32% who actually retired in that age range. The study cites three primary reasons why so many people retire earlier than planned: health or disability, layoff or company closure, and having to care for a spouse or other family member. The study also notes that one in 10 workers plan to never retire. Even if you’re willing to keep working, the statistics are clear: most people end up retiring earlier than planned.

For a healthy 65-year old couple, there is a good chance that at least one of you will live into your 90’s. If you still think you don’t need a retirement plan because you will keep working, do it for your spouse, who might have 25-plus years in retirement if something were to happen to you. Don’t make your plan’s success dependent on your being able to keep working in your 70’s and 80’s.

Realistic Solution: Make it a goal to be financially independent by your early 60’s; then you can work because you want to and not because you have to.

A comprehensive financial plan addresses these concerns and establishes a realistic framework for funding your retirement. And whether you’re 30 or 60, it is never too early, or too late, to make sure you are on track for financial independence.

5 Retirement Strategies for 2015

Posted On December 1, 2014 By Admin In Retirement Planning /

For 2015, the IRS has announced that contribution limits will increase for a number of retirement plan types. For 401(k) and 403(b) plans, the annual contribution limit has been increased from $17,500 to $18,000. The catch-up amount for investors over age 50 has increased from $5,500 to $6,000, so the new effective limit for participants over 50 is now $24,000. Be sure to contact your HR department to increase your withholding in January, if you are able to afford the higher amount.

Traditional and Roth IRA contribution limits will remain at $5,500, or $6,500 if over age 50. SIMPLE IRA participants will see a bump from $12,000 to $12,500, and SEP IRA contribution limits are increased from $52,000 to $53,000 for 2015.

If you’re not sure where to start, here are my five recommendations, in order, for funding retirement accounts.

1) Choose the Traditional Plan

More and more employers offer Roth options in their 401(k) plans, but I believe the most investors are better off in the traditional, pre-tax plan. The only way the Roth is preferable is if your marginal tax rate is higher in retirement than it is today. The reality is that your income will probably be lower in retirement than when you are working. Even if your income remains the same 20 years from now, it is likely that tax-brackets will have shifted up for inflation and you may be in a lower tax rate. Lastly, there has been continued talk of tax simplification, which would reduce tax breaks and potentially lower marginal tax rates, which would also be negative for Roth holders. So, my advice is to take the tax break today and stick with the pre-tax, regular 401(k).

2) Maximize Employer Plan Contributions

Your first course of action will always be to maximize your contributions to your employer plan. Many individuals do this, but I’m surprised that with many couples, the lower paid spouse often does not. If you’re being taxed jointly, every dollar contributed reduces your taxes at your marginal rate. And don’t forget that since 2013, on income over $250,000, couples are subject to an additional 0.9% tax on Earned Income and an additional 3.8% on Investment Income to provide additional revenue to Medicare. Add the 3.8% Medicare Tax to the top rate of 39.6%, and you could be paying as much as 43.4% tax on your investment income. That’s a big incentive to maximize your pre-tax contributions as much as you can.

3) Traditional IRA, if deductible

If you maximize your employer contributions for 2015, and are able to do more, here is your next step: If your modified adjusted gross income is under $61,000 single ($98,000 married), then you can also contribute to a Traditional IRA and deduct your contribution. If your spouse is covered by an employer plan but you are not, the income limit is $183,000. This opportunity is frequently missed by couples, especially when one spouse does not work outside the home.

And of course, if neither spouse is covered by an employer retirement plan, both can contribute to a deductible Traditional IRA, without any income restrictions.

4) Roth IRA

If you make above the amounts in step 2, but under $116,000 single, or $183,000 joint, you are eligible to contribute to a Roth IRA. If your income is above these amounts, you would not be eligible to directly contribute to a Roth IRA. However, if either spouse does not have a Traditional IRA (including SEP or SIMPLE), he or she would be able to fund a “Back-Door Roth IRA”. This is done by contributing to a non-deductible IRA and then immediately converting to a Roth. Since there are no gains on the conversion, the event creates no tax.

5) Self Employment

If you have any 1099 income, are self-employed, or work as an independent contractor, you would also be able to contribute to a SEP IRA in addition to funding a 401(k). You can contribute to both accounts, subject to a combined limit of $53,000, if you have both W-2 and 1099 Income.

One option I’ve not seen discussed often is that someone who is self-employed could also fund a SEP and convert it to a Roth. If you don’t have any other Traditional IRAs, this could, in theory, be used to fund a Roth with up to $53,000 a year. The conversion would be a taxable event, but it would be cancelled out by the deduction for the SEP contribution.

There are quite a few variations and details in terms of eligibility for each family. Want to make sure you’re taking advantage of every opportunity you can? Give me a call to schedule your free planning meeting.

How Some Investors Saved 50% More

Posted On November 18, 2014 By Admin In Financial Planning /

While some people view risk as synonymous with opportunity, the majority of us don’t enjoy the roller coaster ride of investing. Our natural proclivity for risk-avoidance can, unfortunately, become a deterrent in deciding how much we save. Without having specific goals, investors often default to a relatively low contribution rate to retirement accounts and other investment vehicles. They commit only how much they feel comfortable investing, rather than looking at how much they actually need to be saving in order to fund their retirement or other financial goals.

In the November issue of the Journal of Financial Planning, Professors Michael Finke and Terrence Martin published a study of 7616 people born between 1957 and 1965, looking at whether working with a financial planner produced improved outcomes for accumulated retirement wealth. Here are their conclusions:

Results indicate consistent evidence that a retirement planning strategy and the use of a financial planner can have a sizeable impact on retirement savings. Those who had calculated retirement needs and used a financial planner… generated more than 50% greater savings than those who estimated retirement needs on their own without a planner.

When I read the executive summary of their article, I wondered if perhaps the results reflected that higher income people were simply more likely to use a financial planner. However, the authors took this into consideration. They controlled for differences in household characteristics such as income, education, and home ownership… Even after controlling for socioeconomic status, households that used a financial planner and calculated retirement needs had significantly higher retirement wealth accumulation across all quantiles relative to households with no plan.

Interestingly, the authors noted that this result of 50% higher wealth was not due to investment performance. When they looked at individuals who used a financial advisor who was not doing a comprehensive plan (such as a stock broker), they noted that using a planner without estimating retirement needs had little impact on accumulation compared to having no retirement strategy at all.

And that’s why we put planning first at Good Life Wealth Management. Goals dictate actions. Only when we have a clear picture of what you want to accomplish will we will know if you are on track or behind schedule. We’re more willing to save when we are working towards a finish line, as opposed to worrying about what the market is going to do next. If you’re looking for a comprehensive advisor to bring clarity to your goals and to carry out your game plan, I hope you’ll give me a call.

Catching Up for Retirement

Posted On July 28, 2014 By Admin In Retirement Planning /

A common rule of thumb is to save 10% of your income each year for retirement. If you started in your 20’s and invested for 30-40 years, this may well be adequate. But if you currently aren’t saving at this level, 10% can seem like a daunting amount. And if you got a late start or had some financial set-backs along the way, you may need to save even more.

What can a late starter do to get caught up on their retirement goals? Here are 5 ideas to help you take positive steps forward.

1) Save half your raise. When you get a raise, before you receive your next paycheck, increase your 401(k) contribution by 50% of the raise. You’ll still see an increase in your paycheck, but have a better chance of keeping the money which is automatically withheld, rather than taking the cash and hoping to have some left over to invest at the end of the year. This strategy works well for careers which have predictable, steady raises.

2) Downsize. If your kids are out of the house, you may not be needing all the space in your current home. By downsizing to a smaller home, you may be able to free up some home equity and invest those proceeds into investments with a potentially higher return. Additionally, a smaller home will have much lower expenses, including utilities, insurance, and property taxes.

If you really want to make a big impact on your finances, you have to look at the big expenses. For someone in their 50’s or 60’s, cutting out a daily latte just isn’t going to make enough of a difference. Many people have an emotional attachment to their home, which is completely understandable. However, if downsizing makes sense for you, you should try to make that change as soon as possible. Your home is one of your largest expenses and you want to make sure that it isn’t holding you back from achieving other important goals.

3) Spousal IRAs. Most people are aware of the catch-up provisions available after age 50 in their 401(k) or 403(b) plans at work, but many couples aren’t aware of their eligibility to fund an IRA for a spouse who doesn’t work or who doesn’t have a retirement plan. For 2014, the IRA contribution limits are $5,500 or $6,500 if over age 50. Here are the rules for some common scenarios:

– If neither spouse is covered by an employer plan at work, then both can contribute to a Traditional IRA and deduct the contribution, with no income restrictions. Both can contribute to an IRA, even if only one spouse works.
– If only one spouse is covered by an employer retirement plan, then the other spouse can contribute to a deductible Traditional IRA, if their joint MAGI is below $181,000 (2014).
– My personal favorite: if either spouse does not have any IRAs, that spouse can contribute to a Back-Door Roth IRA. There are no income restrictions to this strategy.

4) Social Security for divorcees. A common reason why individuals are behind in their retirement saving is divorce. If you were married for at least 10 years, you are eligible for a Social Security benefit based on your ex-spouse’s earnings. Many divorcees are not aware of this because spousal benefits are never listed on your Social Security statement.

The spousal benefit does not impact your ex-spouse in any way and they will not know you are receiving a spousal benefit. You do not have to wait for (or even know if) your ex-spouse has started to receive their benefits. We’ve often found that someone who was out of the workforce to raise a family or had a limited earnings history will have a very small Social Security benefit based on their own earnings and isn’t aware they are eligible for a benefit from a high-earning ex-spouse.

Details: you must be at least 62, unmarried, and the spousal benefit will only apply if greater than your own benefit. To apply, you will need your ex-spouse’s name, date of birth, social security number, beginning/ending dates of marriage, and place of marriage.
See: http://www.ssa.gov/retire2/divspouse.htm

5) Don’t get aggressive. For many investors, the temptation is to try to eke out extra return from their investment portfolio to make up for the fact that they are behind. They take a very aggressive approach or try to day trade. This is very risky and the results can be devastating. Invest appropriately for your risk tolerance, objectives, and time horizon, but stay diversified and don’t gamble your nest egg.

Who’s Going to Pay for Your Retirement, Freelancer?

Posted On June 26, 2014 By Admin In Retirement Planning /

A regular employee has a steady paycheck which makes planning and budgeting easy. For a freelancer, your income may fluctuate greatly from month to month and be very difficult to predict from year to year. You may not know what work you will be doing six months from now and that’s likely to be a more immediate concern than retirement which could be 20 or 30 years away.

It’s often impractical for a freelancer to save up a large lump sum investment each year. What does work for freelancers is to “pay yourself first” by setting up a monthly automatic investment program into an Individual Retirement Account (IRA). This forces you to budget for retirement savings just as you would do for any other bill, such as your car payment or rent. It is easier to plan for smaller monthly contributions and this creates the same regular investment plan as an employee who is participating in a 401(k).

The maximum annual contribution for an IRA in 2014 is $5,500, which works out to $458 per month. If you aren’t able to contribute the maximum, that’s okay, there are mutual funds that will let you invest with as little as $100 a month. The most important thing is to get started and not put it off for another year. You can always increase your contributions in the future as you are able. If you are over the age of 50, you can contribute an additional $1,000 a year into an IRA, a total of $6,500 a year, or $541 per month.

If you can use a tax deduction, open a Traditional IRA. If you don’t need the tax deduction, and meet the income limitations, select a Roth IRA. Additionally, there is another reason the Roth IRA is very popular with freelancers. Many freelancers worry about hitting a slow patch in their business and needing to tap into their savings. A nice benefit of the Roth IRA – which may help you sleep well at night – is that you can access your principal without tax or penalty at any time. So if you do have an emergency in the future, you would be able to withdraw funds from your Roth IRA. (Principal is the amount you contributed; if you withdraw your earnings (the gains), the earnings portion would be subject to income tax and a 10% penalty if you are under age 59 1/2.)

If you are able to contribute more than $5,500 (or $6,500 if over age 50), the SEP-IRA is your best choice. You could contribute as much as $52,000 into a SEP this year, if your net income is over $260,000. The contribution for a SEP is roughly 20% of your net profit each year, so it works great for freelancers who want to save as much as possible. Why not just recommend a SEP for all freelancers? The challenge with a SEP is that it is impossible to know the exact dollar amount you can contribute until you actually prepare your tax return each year. That’s why most SEP contributions are not made until March or April of the following year. For freelancers who are getting started with saving for retirement, your best bet is to first maximize your contributions to a Traditional or Roth IRA through automatic monthly deposits. Then if you want to make an additional investment, you can also fund a SEP at tax time. A lot of investors assume that you cannot do a SEP if you do a Roth or Traditional IRA, but that is not the case, you can do both.

Being a freelancer can be very rewarding and fulfilling, but it does carry some additional financial responsibilities. You don’t have an employer to pay half of your social security taxes or to provide any retirement or insurance benefits. Unlike traditional employees, however, many freelancers don’t go from working full-time one day to completely retired the next day. What I often see is that many freelancers choose to keep working but reduce their schedule and select only the projects which really interest them. In this manner, they are never fully retired, but still stay active and have multiple sources of income. Regardless of your plans or intentions for retirement, my job is to help you become financially independent, so you work because you want to and not because you have to.