For Self-Employed Workers, Retirement Is Flexible

Self-employed Americans value flexibility in their work and are looking for that same quality in their retirement, according to a study.

Half of self-employed respondents chose to work for themselves because they wanted to set their own hours and schedule, and 53% said they like being their own boss, according to the report released in late January by Transamerica Center for Retirement Studies (TCRS) and the Aegon Center for Longevity and Retirement (ACLR).

Those respondents apply that same mindset to retirement. Almost 70% picture a flexible transition into retirement, either by slowing down before they fully retire, continuing to work occasionally through retirement, or just not retiring at all. Their top reason for continuing to work in retirement isn't because they have to, but because they want to keep active and engaged, the report found.

TCRS and ACLR surveyed 1,600 self-employed workers from 15 countries for the report. Those self-employed workers include small business owners running their own business, partners in professional businesses and micro-firms, as well as sole proprietors, freelancers, contractors and seasonal workers.

The Bureau of Labor Statistics found that in 2015, 15 million people were self-employed, accounting for 10.1% of total employment in the United States.

The rise of the gig economy makes it more important for investors to think about retirement, as there are more opportunities for earning outside traditional employment.

"At a time of rapid technological advances and societal changes, the increasing prevalence of the self-employed not only represents a change in how people work, it also calls for changes in how people save, invest and plan for retirement," the report noted.

Catherine Collinson, president of the Transamerica Center for Retirement Studies, noted that as more people are earning income in nontraditional ways like the "gig economy, it's more important than ever to focus on the self-employed and ensuring that they too are saving and planning for retirement."

She told ThinkAdvisor.com, "societally, we have all sorts of mechanisms in place to help workers plan and save. Now is the time that we also need to expand and make sure that the self-employed have the same access and ability to plan and save and, most of all, that they're actually following through."

As employer-sponsored defined contribution plans have taken over as the predominant way Americans save for retirement, self-employed workers can struggle to keep up with their counterparts at other companies. They obviously have a greater burden in finding and implementing a retirement plan than employed workers, and most don't get the benefit of an employer contribution to pad their savings, according to the report.

Furthermore, only a third of self-employed respondents called themselves habitual savers. (The report noted that statistic is skewed by the sole proprietor respondents, who account for two-thirds of the self-employed sample.) Self-employed workers who employ others, like small business owners, were much more likely to say they're regular savers: 44% compared to 29%.

Another distinction between sole proprietors and self-employed workers who employ others is the role the business will play in funding retirement. Just 11% of sole proprietors said the sale of their business will provide a source of income in retirement, compared to 20% of the employ-others cohort. In the U.S., 15% said they were planning on selling their business to prepare for retirement.

"In both cases," Collinson said of sole proprietors and self-employed employers, "it is so important to do a reality check in terms of their true ability and potential to monetize those assets. Valuations fluctuate tremendously, and human nature may be to err on the side of being optimistic."

Savings, Not Sale, Main Source of Income

Self-employed workers around the world said their savings and government benefits will be their greatest sources of income in retirement.

One area advisors can play an important role in self-employed clients' planning is "helping guide [them] through the types of tax-advantaged retirement accounts that are best for them; if it's a traditional IRA, a Roth IRA, a SEP," Collinson said. There are many different options that could work, and advisors can be "invaluable" in deciding what's best for a particular client "and then, of course, getting it set up and running, and ensure they are consistently contributing to it," she added.

Self-employed Americans can save for retirement in an individual or solo 401(k), which allows them to contribute up to $18,000 per year, or $24,000 if they're 50 or older. They can also contribute an additional 25% of earnings (up to a maximum of $53,000 in 2016, or $54,000 in 2017) as "employer" contributions.

Self-employed workers can use a solo 401(k) to cover themselves and their spouse, and still be exempt from discrimination testing.

Elective deferral limits on a 401(k) plan are by person, not by plan, according to the IRS. Self-employed workers like freelancers or contractors who have a solo 401(k) but also participate in another employer's 401(k) should keep that in mind when planning their annual contributions. Plans with more than $250,000 have to file Form 5500-SF with the IRS.

With a simplified employee pension (SEP), self-employed workers can contribute no more than 25% of their net earnings, up to $54,000 in 2017 and $53,000 in 2016. A SIMPLE IRA lets workers contribute up to $12,500 and an additional $3,000 for workers 50 or older. They can also make either a 2% fixed contribution or a 3% matching contribution if they have employees.

The TCRS report found self-employed workers were more likely than non-self-employed workers to count stocks, investment property and business assets among their sources of retirement income.

US Workers Need Help Planning

Self-employed Americans are slightly better prepared for retirement than their global counterparts. They're more likely to be habitual savers, much more likely to have a written retirement plan and slightly more likely to have a backup plan. In fact, self-employed Americans were more likely to have a backup plan than a written plan (39% to 20%), the report found.

Unfortunately, that can't be interpreted as workers taking a serious approach to planning, Collinson said. With so few people taking the time to write out a retirement strategy, those backup plans are more likely a vague Plan B than a cogent plan.

"Among the self-employed in the U.S., it's vitally important that they have both a written retirement plan and a backup plan because they don't have employer benefits to fall back on," Collinson said. "With an absence of employer benefits, they also don't have all the planning tools that come with a 401(k) or a pension plan."

Collinson added that retirement plans may change as an investor's situation and goals change. Advisors can help self-employed clients by codifying "a retirement strategy in writing so that it can be a planning tool. Things change over time and we need to update our plans accordingly, [but] very few have something in writing."

Self-employed workers were less likely to say they would rely on government benefits than employed workers, the report found. Self-employed people in the U.S. must still pay Social Security and Medicare taxes through the Self-Employment Contributions Act. The tax for self-employed workers in 2016 was 12.4% on earnings up to $118,500, and a 2.9% Medicare tax on their entire earnings.

Although TCRS doesn't have research specifically addressing retirement preparation among RIAs, many of whom are themselves self-employed, Collinson referred to the parable of the cobbler's children.

"We often hear about the cobbler whose children are running around barefoot," she said. "It's a good question to ask themselves: Are they taking as good of care of their own retirement and their family's retirement as they are their clients'? Given that so many [RIAs] are self-employed, are they using all of the tools and resources that they offer their clients for their own personal retirement?"

— Read Now You Need Even More Money for Health Care in Retirement: EBRI on ThinkAdvisor.