One of the biggest downsides to being a contractor is the lack of benefits from your employer. In a lot of cases, contractors are working side-by-side with employees who are getting full benefits (retirement, health insurance, paid leave, etc.) while receiving none of the same consideration or compensation. While leave and health insurance can be trickier to figure out on your own, it’s actually fairly straightforward to start planning for retirement as a contractor or otherwise self-employed individual.
First of all though, why is it important? I’m sure we have probably all heard the spiel from well-meaning older generations about ‘investing in our future, taking care of ourselves as we grow older, getting a head start‘ and so on. But for someone who is living–as a lot of contractors in the heritage industry are–from paycheck to paycheck, it can sound pretty unreasonable to set aside 15% of your precious income into a financial system that you may or may not understand and cannot easily access. However, if you have a bit of money to spare after every few paychecks, it really will pay off to start setting aside some money early on- compounding interest really is the key to making enough to retire by a reasonable age. And it turns out, contractors have a bit of an edge over other employees when it comes to retirement savings.
While people who are employed by larger organizations have a 401(k) as their retirement account, self-employed individuals can open what’s called a SEP-IRA, or Self-Employed Individual Retirement Account. While this functions very similarly to a 401(k) in that you put money into the account to be invested in the stock market, there are a few key differences that individualize this type of account for contractors. Primarily, the difference lies in the fact that, because you don’t have an employer contributing to your account as you would with a 401(k), your threshold for how much you can contribute to your account per year is much higher. However, the real benefit comes through the fact that you have total control over how much money you put in to your account, on what schedule you contribute, and what you can invest in. While 401(k)s are usually set up to automatically deduct and invest a certain percentage of each paycheck, in a SEP-IRA you make all the contributions manually, by yourself. This means you have complete freedom to change the amount and frequency of your contributions; if you have a good month and can invest 10% of your paycheck then great, but you can also go months with contributing just 1% or even none. It’s all up to you and will be as flexible with your budget as you want it to be.
So, if this is all sounding good so far, how does one actually set up a SEP-IRA? It’s pretty straightforward. Simply find an investment company you want to work with (Fidelity, T. Rowe Price, Principal, etc.) and follow the steps to set up an account– this can usually be done online in a matter of minutes and most places don’t require an initial deposit of more than a hundred dollars or so (save up for the initial deposit if you need!).
From there, you can get into the second big benefit to having a SEP-IRA which is that you can choose what to invest in and how. If this sounds overwhelming (and it can be!) there’s actually a really simple solution: just like with a 401(k), you can put all of your money into a fund that has been specialized for the year you plan on retiring. It should be called something like, for instance, ‘2060 Fund’. In case you’re new to the stock market or retirement planning, basically a fund like this will automatically invest your money in a variety of stocks that will overtime become more conservative, meaning the closer you get to your retirement goal year, the less risky the fund will become. It’s a really simple, hands-off option identical to that of most 401(k)s! However, if you know a little about the market or want to make your own investment choices, the beauty of a SEP-IRA is that you can invest in anything you want! This is great if you are just starting out and/or trying to make up for lost time because you can choose to invest in something with more aggressive growth than your retirement year fund might provide, giving you the chance to earn more money over a shorter period of time.
If you’re totally new to the idea of retirement planning and need a quick recap, here it is: setting up a SEP-IRA is a relatively quick process, and once set up you can determine how much and how frequently you contribute to the account. Furthermore, you can control what and how you invest, making it easy to personalize your retirement fund based on your personal goals. Ultimately, as long as you have enough to make the minimum deposit required to open an account, there is no reason to not have a SEP-IRA and just contribute as much as you can, when you can. It’s the best of both worlds- you can make the system work with your ever-changing budget while still knowing you are making a difference for your future.