The self-employed face a financial challenge during Covid-19: saving for retirement

Saving for retirement could look very different during the pandemic.

Especially vulnerable are independent business owners and the self-employed, who in the best of times are on the hook for not only funding their own future retirement but daily income, as well. Even before the pandemic, just 13% of those tax filers participated in a workplace retirement plan.

The self-employed are likely now having an even harder time saving for retirement — despite being able to collect jobless benefits using the pandemic unemployment assistance program created by the CARES Act. (Independent workers like the self-employed, independent contractors and gig workers made up nearly half of the 31.5 million people receiving unemployment nationwide as of mid-June.)

Obviously, a lot of people's revenue is down, says Michael Kojonen, president of Principal Preservation Services, in Woodbury, Minnesota. 

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If your retirement plan is some type of individual retirement account, you may want to hold off making contributions, since you have until April 15 to decide, he says. 

It's possible that the first quarter of 2021 will show better profits. "It's tough, because it depends on your industry," Kojonen said. "Don't make any quick decisions about funding it early."

Kojonen is still deciding how to fund his company's simplified employee pension IRA since regulations require all contributions to be equal to the same percentage of compensation.

"If I decide to put 25% of my income in, [all my employees] get a 25% contribution from the business, as well," he said. "We'll see how the last quarter of the year ends."

Keep in mind the following points when weighing how much to save: 

1. The top thing is not to tie up cash. "An individual should have three to six months of expenses set aside," Kojonen said. "For my business, I have at least a year of expenses. The pandemic scared everyone into having bigger reserves."
2. Consider how your budget would be impacted if there's another shutdown, or if you think your business might close.
3. You might want to hold off on large expenditures. "This might not be the best year to get into a  long-term debt obligation," Kojonen said. Even with enticing offers, such as 0% financing on some vehicles, you are still putting your name on the dotted line.
4. Anticipate upcoming expenses, such as a Paycheck Protection Program loan you might have to repay in full or in part. 

"A [tax] deduction is great, but it's not going to be more important than your business," Kojonen said. 

If you're able to save for retirement, though, you'll get a break on taxes.

"The government has incentivized saving," said Chad Parks, founder and CEO of the retirement plan provider Ubiquity Retirement and Savings in San Francisco.

An easy calculation you can make to help you understand how this works, Parks says, is to imagine someone who pays around 30% of their salary in taxes.

If this person can set aside $1,000 a month, $300 of that is the money that would otherwise have gone to taxes, Parks said. "The out-of-pocket is only $700 to be able to save $1,000," he said. "I call it the government match."

The choices of retirement plans can seem overwhelming.

"The real differentiator is, can you save more than $500 a month?" Parks said. A monthly amount makes it understandable, so you can compare the number to other fixed expenses.

That $500 adds up to $6,000 over a year, the individual retirement plan limit for 2020. If you're older than 50, you can save an additional $1,000, for a total of $7,000.

Opening an IRA is the simplest thing to do and, if you're not going to save more than $500 a month, it's a good choice, Parks says.

You can open an IRA at almost any financial institution, including banks, credit unions and investment houses.

"If you're under 40, a Roth IRA is probably the better option because you have decades before retirement," said Parks, referring to an IRA initially funded with after-tax dollars that you can tap in retirement entirely free of taxes. For those who are older and investing more conservatively, a traditional IRA — where you get the tax break the year you put the money in but pay taxes later on distributions — is probably the right alternative.

Check online tools and calculators to decide between a traditional IRA and a Roth IRA.

Once you open your account, set up an automatic transfer to sweep a deposit into your retirement account so you don't have to think about it.

"Tie this to your paycheck," Parks said, whether that's once or twice a month.

The SEP IRA is another possibility. SEP IRA accounts have higher savings limits than a traditional IRA, but contributions are calculated differently. As a business owner, you can contribute whichever amount is lower: 25% of your earnings or as much as $57,000 a year. 

(A simplified employee pension (SEP) IRA is a retirement savings plan established by employers — including self-employed people — for the benefit of their employees and themselves.)

That limit might make the solo 401(k) plan more attractive, since the amount you defer is entirely up to you, as long as you stay within the contribution limits. "If you earn $19,500 and want to put it all into a self-employed 401(k), you could," Parks said. "That would reduce your taxable income to zero."

The maximum amount a self-employed individual can contribute to a solo 401(k) for 2020 is $57,000 if they are younger than 50. Individuals 50 and older can add an extra $6,500 per year in "catch-up" contributions, bringing the total to $63,500. Most major providers — including Fidelity, Schwab and Vanguard — offer a solo 401(k).

You may have heard amounts ranging from 10% to 20% of your salary as the percentage you should save for retirement. If you're dealing with multiple financial obligations — rent, student loans, credit card bills — that can be daunting.

It sounds cliched, but it's a fact, says Rick Irace, head of service and operations for Ascensus' retirement division in Dresher, Pennsylvania. The importance of saving any amount and doing it consistently can't be overstated. "Every little bit helps when it comes to saving for retirement," he said.

Just as critical is discipline. "Someone who is stretched thin financially can start by simply setting 1% of their pay aside," Irace said.

You can ease into saving without feeling too much pain. Set a goal of increasing this amount by a percentage point or two until you reach your target, Irace says.

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