Updated on 04.23.08

Retirement Savings: How I’m Doing It

Trent Hamm

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.

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  1. Eric says:

    How about some real estate (physical) or REITs to balance any potential inflation risks? I love equities, but a little extra physical “stuff” couldn’t hurt. Unless you own your home – then you might already be balanced.

  2. Frugal Dad says:

    Sounds like a solid plan. I’ve delayed opening a Roth IRA until the current tax year, and it is a source of much financial regret. If I had started 10 years ago, when I was 20 and working my way through school, I could already have a significant amount saved for retirement. That’s why I tell every new college grad I run in to – if you want to retire a millionaire open a Roth IRA and begin to fund it today!

  3. Andy says:

    Thanks for the clarification. Is setting up the SEP-IRA difficult at all for Vanguard? Do you know if it will make taxes any more difficult or confusing? Or is it just like reporting it going into a 401k. Thanks.

  4. !wanda says:

    I’m not allowed to contribute to my IRA because I’m a grad student paid on a fellowship, which is apparently not “earned income.” Of course my university doesn’t have a 40* for me to put money into, either. There’s a postdoc in my lab who has is 32 and has been in this situation for all his working life, since he is a very good scientist who has always gotten prestigious fellowships! (Fellowships tend to pay more and come with other benefits, but they are generally not “earned income.”) Is there another way I can save for retirement using tax-advantaged funds? Or do I just have to save more money?

  5. Andrew says:

    I setup a Roth IRA at Vanguard earlier this month for myself and a Traditional IRA for my wife. I maxed out my 2007 contribution and rolled over an IRA my wife’s accountant had setup over at PIMCO/ALLIANZ. Process was really simple, just gave them the account info and they did the rest. I started out with their 2045 Target Retirement fund (I’m 23, wife is 27) since I was over $3k in each account.

  6. JReed says:

    I and my husband have both been self employed for over 23 years…We only use Roth IRAs now because I firmly believe we will be taxed in retirement at a higher rate than we are now. This country cannot sustain the social security and medicare programs for the masses of baby boomers (let alone potential universal health care) with out raising taxes. The real bill for us is not the taxes we pay as self employed but the doubling of our social security payments. SEP/IRA’s do not reduce our social security bill and only minimally reduce our tax bill. Thus, we max out the Roths and just save and invest the rest. If we had employers matching our 401K contributions and picking up half the ss tab, of course we would not use the Roth first.

  7. jeff says:

    I was under the impression you could not contribute to a roth ira & sepp-ira in the same year. Of course i contribute to my 401k keough in the same year as well as my roth ira.

  8. Credit says:


    According to the accountant I use, the portion of the fellowship used for tuition, fees and required books, supplies and equipment is not taxable. However, the amount used for other expenses such as room, board and travel is taxable and this portion is considered earned income. Most of those on fellowships ignore this rule and just don’t pay the taxes. So if you want to follow the rules and pay the taxes, then you can contribute to a Roth IRA. However, please don’t make Trent’s mistake of putting your money into an S&P 500 index fund unless you like losing money and paying the opportunity cost to not have to think about your investments.

  9. Susan says:

    !wanda & credit:

    I think !wanda is right, if it is not earned income (i.e. you do not get a w-2 for the stipend/fellowship), you cannot invest in a Roth IRA. Like Credit, I thought since I self-reported and paid taxes on the stipend, I could contribute to a Roth IRA. I found out (using TurboTax this year) this is not the case.

    I am also surprised Trent can contribute to a Roth IRA while he is self-employed. Trent – you may be OK because you are married, but if you don’t get a w-2 for your self-employment, can you really contribute to a Roth IRA? (Or do you get a w-2 for some of your income?)

    Just curious, I am still trying to understand the system. Since I thought I could no longer contribute to a Roth IRA, I decided to invest in mutual funds.

  10. clint says:

    I need to get started sooner rather than later. I have spent so much time getting out of debt that I have put off starting to pay into retirement.

    Thanks for the bump in the right direction.

    Clint Lawton


  11. Ryan McLean says:

    I am very keen to work towards may retirement. I am 20 now and I want to be able to retire (if I want to) before I am 30
    So thanks for the advice

  12. Ed says:

    I believe that as long as Trent’s wife is working, Trent can contribute to a Roth IRA. As long as she makes $10k, they can both put in their $5k.

  13. AndyS says:

    Thanks for the information, I was thinking of starting my own business and was meaning to look into self funded retirement plans. Found it here!

  14. !wanda says:

    @Susan and Credit: My mom is an accountant, and she read over everything very carefully. Because I do not get a W-2 (or possibly a similar, obscure document) and am not a farmer or fisherman, I do not have “earned income.” As for not paying taxes, the penalties for crossing the IRS are high, and I prefer to stay on the correct side of the law. So I send in my estimated taxes 4 times a year. My program made it pretty clear to us that we were expected to pay.

  15. Shawn says:

    JReed – The PLAN is for Roth IRAs to be tax-free withdrawls. Down the road when the budget blows up, do you really think they are going to let someone with $1.5 million in a Roth IRA pull it out without taxes, no matter what WAS promised? Of course not. They’ll tax it at the going rate, especially the “rich” people with over a certain amount. Just like this mortgage mess, the people that save and invest are going to be forced to cover for the irresponsible.

    Contributing to an IRA or Roth IRA before the SEP is an interesting approach since you avoid the self employment tax on that amount of money also. I fill my IRA each year, and plan to open my SEP-IRA soon.

    Trent – For your young age, you should be in higher risk investments. Small Cap growth (No. American, and Intl.). Adjusted for inflation, your Vanguard fund is only going to return 3-4% per year in real terms. Success to you.

  16. Credit says:

    One of the problems with the rule on fellowship money is the metric of performing a service for the money. Clearly TA and RA positions would be included. Most fellowships have some performance clause, but if yours does not, it may never be considered earned income. I would trust a CPA over TurboTax. Many students on fellowship in sciences and engineering do consulting work on the side. This has been profitable for us and it only takes a few hours a week to make enough to offset a maxed out Roth IRA. I’m not sure what field you are in, but this is an option for most students. You have to check into the conflict of interest and employment rules at your university.

  17. Esme says:

    What about a SEP 401(k)? My understanding is then you can contribute up to $15,500 (like a regular 401(K)) as an “employee” contribution and then up to a certain percentage of earnings as the “employer” contribution? I think it allows more tax deferred contribution than the SEP IRA but I could be wrong.

  18. gr8whyte says:

    @ !Wanda : I’m amazed your school doesn’t offer a 403(b); does it offer a 457?

  19. Saving Freak says:

    The great thing about being self employed is that you can set your kids up for life. If you give them jobs to do for your business you can pay them money that qualifies as earned income. At that point you can put a portion of that money int a ROTH IRA. Since they won’t make enough to be taxed it is tax free money that never gets taxed and they can start saving for retirement as early as you want to set it up.

    A friend of mine has a seven year old with $200 in a ROTH. He helps her put in about $20 a month now.

  20. !wanda says:

    @gr8whyte: Yes, there are retirement plans, for staff. I’m just a lowly grad student :P .

  21. Becky says:

    “(basically, no withdrawing until the account is more than 5 years old OR you’re over 59 1/2 years of age)”
    –Just to clarify, don’t you mean the account has been open AND you are over 59 1/2 years of age?

  22. Becky says:

    *open more than 5 years AND…*

  23. Nathan says:

    “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.”

    Aren’t mutual funds already diversified? And don’t you preach index funds? How much more diversity can you get? Isn’t there such a thing as TOO much diversity?

  24. Tom says:

    No one’s mentioned the SIMPLE IRA… I wonder why. Here’s what my accountant advised me when I was self-employed a few years ago:

    First set up a corporation. An S Corp or LLC most likely, but it depends on your situation. Have a lawyer do it, it cost me $800 but was well worth it.

    Make yourself an employee of your own corporation and pay yourself a modest salary, something the IRS would consider reasonable. For a part-time job, $1000 a month might be reasonable.

    Then set up a SIMPLE IRA which allows you to contribute up to 100% of your salary, up to a limit of something like $12K.

    With a $12K salary and a SIMPLE-IRA, you can put your entire year’s salary into your retirement plan, easily maxing out the contribution limit. To do that with a SEP-IRA you’d have to pay yourself a huge salary. A huge salary is bad because you’ll pay an extra 15% in Social Security taxes on it.

    The corporation’s profits over and above your salary would come to you in the form of dividend distributions. You do not pay Social Security taxes on this and it’s taxed as dividends rather than earned income (i.e. at a lower tax rate, and exempt from things like local taxes which are based on earned imcome).

    Oh, and even for the $12K salary you do earn, you pay no federal tax on that because you’re putting it all into your retirement plan on a pre-tax basis. Not only that, but the corporation can match your SIMPLE IRA contributions up to 100% on a pre-tax basis as well, because the match is an expense to the corporation, and all of the corporation’s expenses are tax deductible.

  25. Tom says:

    Follow-up to my previous comment: I don’t think the “Self-Employed 401(k)” existed a few years ago when I was self-employed. Today, this would probably be better than a SIMPLE-IRA for a self-employed indivual who works alone or with just their spouse. It has a higher contribution cap but still allows you to put 100% of your salary into the plan, which is key to avoiding all the taxes that are based on earned income.

    Which raises another point… with a corporation you can hire your spouse to run some small aspect of your business and use the strategy mentioned previously to double your retirement savings with all the same tax advantages. This is a no-brainer if your spouse has no other employer or has an employer with no retirement plan. If they do have another retirement plan you’d need to look into whether it’s permissible to contribute to both.

  26. Amy says:

    @Nathan: I work for an investment company so I just wanted to share some insight about diversifying. Index funds aren’t always the way to go. An index fund that mirrors the S&P 500 is not really diversified because it only invests in large companies. There are some indices that are more encompassing of the market though. To really diversify, you want to invest in small, mid, and large sized companies, both in the US and abroad. You may also need to throw in some bonds and money markets. (I only deal with mutual funds, but if you have the resources and knowledge, you can go with individual stocks and such, but mutual funds aren’t as risky as indivudual stocks.) It really depends on your specific goals and your age, but the younger you are, (or the farther away your goal is) the more stock exposure you should have and vice versa. Most mutual funds by themselves are not really that diversified, because they only invest in one kind of stock. (ie, small companies or large companies) There is a thing as too much diversification, sometimes I see people with 4 or 5 different large company funds in their portfolio, which is not neccesary, as one good large company fund will provide what you need. The easiest thing to do is go with the target date funds. I’m sorry this is so long but I hope it helps!

  27. Chris says:

    I have a 401k/roth ira question: Being in banking, recently the 401k I had with a previous employer has taken a significant hit. It is down approximately 60-70% to around $15k. I am not overly famaliar with 401k tax stuff, but can I cash out and declare a loss on these funds to move them into a roth ira? My wife also has a traditional ira that I would like to move into a roth ira. I am hoping that if I can take the tax break for the loss on the cash basis, I can move them to the same investments in the roth ira at wait for them to come back up. Any suggestions?

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