A number of people have asked me how I’m saving for retirement now that I’m self-employed, and several more asked yesterday when I mentioned that I was signing up for a SEP-IRA. In order to clarify everything, here’s exactly how I’m saving for retirement as a self-employed writer.
For comparison’s sake, my previous retirement savings were exclusively in 403(b) and 401(k) plans. Even though I planned to open a Roth IRA in 2007 (and even went so far as to fill out the paperwork), I eventually elected not to do it, primarily because of the costs associated with purchasing a house in 2007 and the fact that I was already rolling about 20% into my retirement plan. In fact, my savings in there is quite a bit above what’s considered “normal” for a 29 year old – I have substantially more than a year’s worth of my old salary in there, and it’ll just do nothing but grow over the next 30 years.
My current self-employement retirement planning is handled exclusively through Vanguard. I’ve invested with them in the past, I feel wholly comfortable with the way they do business, I agree strongly with their company’s investing philosophy, and I want to put all of my retirement into index funds, which is what Vanguard specializes in.
So what did I do? Almost as soon as I moved to self-employment, I opened up a Vanguard Roth IRA. A Roth IRA is a retirement account that almost anyone can set up (well, anyone with a Modified Adjusted Gross Income below $114,000 for an individual or $166,000 in a married couple). Each year, you can contribute up to $5,000 to the Roth IRA out of your after-tax money – it isn’t pulled straight out of your paycheck like a 401(k) is. However, once it’s in the account, it’s sweet – as long as you follow the very simple withdrawal rules (basically, no withdrawing until the account is more than 5 years old or you’re over 59 1/2 years of age), you can withdraw the earnings tax free – you don’t have to pay income tax on any earnings in the account (you can also withdraw your contributions at any time without penalty). For a lot more detail, read up on Roth IRAs at Wikipedia.
So, basically, each month I put a few hundred dollars into my Roth IRA at Vanguard – just enough so that after the year’s up, I’ll have contributed my total $5,000 (my wife is considering opening one as well, so that will make our combined contribution $10,000 for the year if she does that). Ideally, then, I’ll contribute $5,000 each year over the next thirty years into this account, taking me right up to retirement age. If I do that, and it earns even just 6% per year, that’s $395,290 I have access to at age 59 1/2, all of it tax free. If I get an 8% return on it, that’s $566,416 – tax free. That’ll certainly help with retirement.
What about the SEP-IRA? So, as I mentioned yesterday, I’m setting up a SEP-IRA through Vanguard as well, mostly because I wanted to contribute more towards retirement than the $5,000 a Roth IRA allows for me. A SEP-IRA allows a self-employed individual to contribute up to 20% of their profits to the SEP-IRA. I’m allowed to invest up to (approximately) 20% of my self-employment income into this plan (though I’m not going to be putting in quite that much). This plan is tax-deferred, meaning that I put in money before paying taxes on it and then pay income tax on everything I take out later on. For the purposes of most people, it’s like a 401(k) for the self-employed, except that you don’t get employer matches.
Right now, I’m contributing roughly 5% of my income each month to this plan – that’s in addition to the Roth IRA, but way under my contribution limits for the year.
How did I invest? In both cases, I set up a regular investing schedule and bought into the Vanguard STAR fund because I didn’t want to put in the $3,000 minimum for other funds. I’ll sell the STAR shares when it reaches $3,000 and move it to another fund. Eventually, I plan on having all of it split among a few funds just to ensure diversity – I want some international stocks, some domestic stocks, etc.
For most self-employed people, particularly those under the cap for a Roth IRA, this is a solid path to follow.