Saving for Retirement: 401(k), IRA, Roth IRA, Bonds & Funds

Does the title send a chill down your spine? If so, you’re not alone. If not, maybe it should. According to a Northwest Mutual’s Planning and Progress study (2019), more than 22 percent of Americans have less than $5,000 saved for retirement and 15 percent have nothing saved at all. Meanwhile, Social Security is set to shrink towards insolvency by the time Millenials retire, while the cost of living will only increase.

If you’re a freelancer, retirement can look particularly grim. But once again, you’re not alone. More than a third of the US workforce is part of the gig economy (Forbes “57 Million Workers Are Part of the Gig Economy,” 2018). That’s tens of millions Americans who derive some or all of their income from sources that aren’t eligible for employer-backed benefits when saving for retirement.

Being a freelancer means almost everything is under manual control: your time, your workload, your location—and yes, your retirement plan. Most freelancers become experts at managing it all, except for that last part. But this is a problem that’s not going to go away.

Fortunately, there are ways for freelancers to set aside money for retirement in a secure and profitable way.

To save for retirement doesn’t mean simply depositing into a savings account and it doesn’t mean gambling it all on the stock market, either. It means finding ways to have your nest egg grow on its own in a sustainable way. For this, you have a variety of options, each with their own pros and cons.

A savvy investor often will incorporate multiple investment opportunities into their retirement portfolio and adjust their investments as their income and lifestyle change. It’s always a good idea to contact a financial professional before investing, but if you’d like to get a basic outline of the options out there, check out some of the most popular below.

The most popular way to save for retirement is through Individual Retirement Accounts (IRAs), which allow individuals to make long-term investments that don’t incur heavy tax disadvantages. For individuals, they’re generally set up through a verified broker, such as a bank, credit union, or brokerage company. Deposited funds are invested in a portfolio of low- to medium-risk investments that can include stocks, bonds, and mutual/index funds.

In their simplest form, the IRA, investors only pay taxes when they withdraw from their account, generally after the age of 60. In a Roth IRA, investors pay taxes upfront, and pay none upon withdrawal. Generally, Roth IRAs are a better pick if you’re in a lower tax bracket than you expect to be in retirement.

A third option, and one of particular interest for freelancers, is the simplified employee pension (SEP) IRA. This account can be opened by an employer, even one who’s self-employed. It offers a basic IRA or Roth IRA account that avoids the complexity of a larger 401(k). SEP plans follow the same tax guidelines as the type of IRA they invest in, but can allow for greater contributions.

Those who invest in IRAs may be eligible for the Saver’s Credit. Designed to motivate low and middle income workers to save for retirement, this tax credit can be worth up to $1,000 per year. In order to collect it, all one has to do is meet certain income requirements and make contributions to an IRA or Roth IRA account in that tax year.

All IRA accounts come with eligibility requirements and deposit limitations. Individuals can only deposit up to $6,000 per year across both an IRA and a Roth IRA, and up to $7,000 per year after the age of 50. For an SEP, individuals can invest up to 25 percent of their earned income, or up to $56,000, whichever is lower. Further eligibility requirements may determine how much of one’s investment is tax deductible. And, in every case, there are further penalties for withdrawing from these accounts before age 60: generally 10 percent.

• Pros: Tax-deferred or tax-deductible, relatively simple
• Cons: Capped contributions, eligibility restrictions

The typical nine-to-five worker with a steady job has a 401(k) plan through their employer. These plans allow a worker to invest money for retirement and have their employer match a portion of that contribution. Those of us in the gig economy are not so lucky. However, it is possible for a self-employed worker to set up their own 401(k), albeit at the cost of complexity.

A solo 401(k) is a 401(k) for a single person with no employees other than themselves and/or a spouse. Depending on IRS calculations, an individual can deposit up to $55,000 per year by making contributions as both employee and employer. This money can then be invested in a variety of funds, stocks, bonds, that other 401(k) options can’t.

A solo 401(k) functions much like its traditional 401(k): money can be invested in stocks, bonds, and mutual funds on a tax-deferred basis. And, generally speaking, an individual can squirrel more away than they could through an IRA-type fund. While a verified broker is often able to take care of the investment itself, it will require an individual to have an employer identification number from the IRS.

Furthermore, not all state taxes are exempt from this type of investment and eligibility requirements play a significant factor. Individuals who want to contribute more than the limits of an IRA account may choose to set up a solo 401(k), while those who don’t want the extra paperwork may look elsewhere.

• Pros: Higher cap for contributions, wide range of investment types
• Cons: Relatively complex, eligibility restrictions

Government bonds backed by the US provide one of the most secure options to save for the future. Each government bond has a maturation date, which can range from anywhere between two to 30 years, depending on the type of bond issued. Over that period, a designated rate of interest is paid out to the investor, and, depending on the type of bond, it can be free of state and federal tax. Furthermore, these bonds can be bought and sold on the secondary market, making them liquid assets.

All retirement portfolios should include some amount of government bonds, as they’re unlikely to lose a significant portion of their value. But they’re also unlikely to gain significant value. A general rule of thumb is that the younger you are, the less you should hold, and, conversely, the older you are, the more you should hold. While government bonds backed by the US are considered some of the safest options for investors, they’re also one of the lowest yielding investments, and in some cases the interest may not keep pace with inflation. Government bonds backed by foreign nations are much riskier: changes in currency rates and interest rates can mean a higher chance of default.

• Pros: Safety, liquidity, partially tax-exempt
• Cons: Low-yield, inflation risk

Certificates of Deposit (CDs) are similar to government bonds, but instead of being backed by a government, they’re backed by a bank. The underlying strategy is the same, however: you invest money for a specified period of time (in this case, typically one to five years) and collect interest payments at a locked-in rate. The shorter maturation period associated with CDs makes them ideal for those who have a targeted investment strategy that spans a particular time-frame.

There are downsides. CDs aren’t liquid and withdrawing early will invoke heavy penalties. Furthermore, they aren’t tax deductible. To decide whether they’re a good investment, you’ll have to do some math. If you take a five-year CD that pays 3 percent a year in interest, that’s a profit of $300 a year on a deposit of $10,000. But if you’re paying a total of 30 percent taxes (across state and federal), you also owe $90 per year on that investment, dropping your profit to $210 per year.

CDs can be a useful addition to your retirement portfolio if you’re in a low tax bracket, want no risk, and have plans to re-invest that money after the deposit’s date of maturation. Furthermore, you’ll have to shop around to find a CD that beats inflation over the timespan of the investment.

• Pros: Safety, short-term
• Cons: Low-yield, taxable, non-liquid, inflation risk

Those who wish to grow their investments at a slightly faster rate often look to the wider stock market and other investments, which come with higher volatility. To somewhat mitigate the risks associated with these types of investments, many look to mutual funds and index funds. These funds, which are controlled by a third party, offer a cross-section of the entire market, avoiding a single point of failure. Both can be included as part of one’s IRA, or used as an investment outside of the IRA’s contribution cap.

Mutual funds are actively managed by financial professionals, while index funds are passively managed. Simply put, that means that mutual funds are trying to pick winners that beat the market benchmark, while index funds are seeking to match the outcome of the larger market But there’s a lot of variation within each type of fund. Some mutual funds may be geared towards growth, while others are geared towards income: the former will take higher levels of risk, while the latter will invest in lower-risk options and include things like government bonds and CDs in their portfolio.

In general, you’ll pay more for an actively-managed mutual fund, as fees need to be paid on the buying and selling of assets within the fund. A passively-managed index fund, however, will make fewer transactions and incur fewer fees. While each fund is different, the average mutual fund expense ratio is around 1 percent, while the average index fund expense ratio is around 0.2 percent. Over a long investment horizon, the difference in costs can be more significant that the difference in potential gains.

• Pros: Higher growth, liquid
• Cons: Higher risk, taxable

The US government incentivizes its citizens to save for retirement through IRAs and 401(k) plans, but it could be doing a whole lot more. To put it plainly, incentivizing someone to do what’s in their best interest isn’t the same as providing what’s in their best interests. That’s why we have public schools instead of simply offering tax-deductible discounts on textbooks one can read at home. And that’s also why many other countries mandate more in retirement contributions from employees, employers, and government. The US should follow suit.

Expanding Social Security is the first step towards securing the retirement future of Americans, but it’s not the only way. Reducing the cost of aging is a logical step that many other rich countries (Denmark, Norway, Sweden, France) take into account. Universal healthcare would allow one’s savings to be spent on retirement, rather than inflated medical costs. Universal education (up to and including the collegiate level) would increase the amount someone could save, reduce the likelihood of at-risk behaviors, and contribute more to the wider economy.

The land of the free has gotten awfully expensive over the years. Americans are saving less and retirement is costing more. Unless we want an unprecedented level of poverty in the oldest section of our demographics, changes need to be made to take care of Americans who have spent their whole lives contributing to the country’s economic growth.

Until those changes are made, it’s time to plan for the future you want.

Matt Zbrog

Writer

Matt Zbrog is a writer and freelancer who has been living abroad since 2016. His nonfiction has been published by Euromaidan Press, Cirrus Gallery, and Our Thursday. Both his writing and his experience abroad are shaped by seeking out alternative lifestyles and counterculture movements, especially in developing nations. You can follow his travels through Eastern Europe and Central Asia on Instagram at @weirdviewmirror. He’s recently finished his second novel, and is in no hurry to publish it.