Retirement Planning Advice for Self-Employed Parent

Dear Anika,

I’m a 38-year-old freelance graphic designer and, being self-employed, I’ve always found the topic of retirement savings to be rather perplexing. It seems like most of the advice out there is tailored towards those who are traditionally employed and have access to employer-sponsored plans like 401(k)s.

On top of that, I have two kids (ages 8 and 10), and I’ve been grappling with how to balance saving for their college education and my retirement.

Could you offer some advice on what retirement savings options are available to self-employed individuals like me? And how should I prioritize my savings between retirement and my kids’ education?

I eagerly look forward to your guidance.

Alex M.

Dear Alex,

Thank you for your thoughtful question and for following my columns in Revyo. I understand that being self-employed can bring unique challenges when it comes to retirement savings. However, there are several effective retirement saving options available to self-employed individuals that can provide substantial benefits.

1. Solo 401(k): A Solo 401(k) (also known as a One-Participant 401(k)) is designed specifically for self-employed individuals who have no employees. It allows you to contribute as both an employer and an employee, increasing your potential for higher contributions. In 2023, you can contribute up to $20,500 as an employee, plus an additional 25% of your compensation as an employer, up to a total cap of $61,000.
2. SEP IRA: A Simplified Employee Pension (SEP) IRA is another popular option. It’s easy to set up, and you can contribute up to 25% of your net earnings from self-employment, up to a maximum of $61,000 in 2023.
3. SIMPLE IRA: A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a good option if you have employees. It’s less complicated and has lower costs compared to a traditional 401(k), but contribution limits are lower.
4. Roth IRA: In addition to the above plans, you may consider opening a Roth IRA, where you can contribute post-tax dollars, and all withdrawals in retirement are tax-free. The contribution limit in 2023 is $6,000 (or $7,000 if you’re 50 or older).

Each of these plans has its own advantages and limitations, and the best one for you will depend on your individual circumstances. For example, if you want to maximize your contributions, a Solo 401(k) or SEP IRA could be a good fit. But if you prefer a plan that’s simple and easy to manage, a SIMPLE IRA or a Roth IRA might be better.

As a parent, it’s understandable that you want to help your children with their education expenses. However, it’s important to remember the adage: “You can borrow for college, but you can’t borrow for retirement.” Essentially, it means that while your intention to support your children is commendable, it should not come at the expense of your own financial security in retirement.

That being said, there are tax-advantaged options available that can help you save for both goals:

1. 529 College Savings Plan: This plan offers tax-free growth and withdrawals for qualified education expenses. Some states even offer tax deductions or credits for contributions. However, funds from a 529 plan used for non-education expenses can be subject to taxes and penalties.
2. Roth IRA: Interestingly, a Roth IRA can also be used to save for college expenses. Although typically a retirement savings vehicle, you can withdraw contributions (not earnings) from a Roth IRA at any time, for any reason, without tax or penalty. This could provide more flexibility if your child chooses not to attend college or gets scholarships.
3. Coverdell Education Savings Account (ESA): This account allows you to contribute up to $2,000 per year, per beneficiary. The funds can be used for education expenses, and the earnings grow tax-free.

I recommend starting by ensuring that you are saving enough for retirement. Once you’ve set up regular contributions towards your retirement that align with your goals, you can then consider contributing to a college savings plan. Also, don’t discount the value of scholarships, grants, work-study, and even student loans in helping to pay for education costs.

I would also recommend working with a financial advisor to navigate these choices and create a strategy tailored to your specific circumstances. These are complex decisions with potential tax implications and an advisor can provide valuable guidance.

Remember, the best thing you can do for your children, in addition to helping them get a good education, is to ensure that you won’t be a financial burden to them in your retirement.

I hope this information is helpful and guides you in your financial journey.

Best Regards, Anika Patel