As more U.S. workers go independent, a retirement time bomb is ticking
NEW YORK - Ask self-employed workers about retirement savings, and a shocking number give exactly the same answer: "What retirement savings?"
The potential consequences are scary not only for them - the nation's growing ranks of entrepreneurs, freelancers, consultants and contractors - but also for the United States as a whole. With more and more people without regular jobs and the benefits that come with them, the nation faces a retirement time bomb.
New data from TD Ameritrade Holding Corp reveals the worrisome state of the retirement savings of independent workers. The brokerage company's Self-Employment and Retirement Survey found that 28 percent of the self-employed were not saving anything at all, and another 40 percent were only saving occasionally, when they said they were able.
At the same time, the ranks of U.S. freelancers, contractors and temp workers are growing every year - to an estimated 40 percent of the workforce by 2020, according to a study by software company Intuit, and up from 30 percent in 2006, according to the Government Accountability Office.
"This is going to be a huge problem," says Jonathan Medows, a Manhattan certified public accountant who specializes in helping freelancers with their finances. "They are already struggling to pay their bills, and then there are all the additional costs like overhead, like quarterly estimated taxes, like medical care. And cash flow can be so inconsistent that it is very challenging to budget."
Until a few years ago, saving was not on the agenda of New York City disc jockey Herbert Holler (real name Ken Hyman). Early in his career, he says, "I was single, living on the Lower East Side, going out every night and living day-to-day."
But now Hyman is 37, with a wife and a young daughter. Despite intermittent paychecks, lack of company-sponsored 401(k) plans and matching contributions - plus additional cost burdens like health insurance - he and his wife are maxing out their annual Roth individual retirement account (IRA) contributions.
"Freelancers have to find a way to save," Hyman says, "or we're all going to be in a lot of trouble."
Even though the U.S. retirement system has not really been designed for them, freelancers must take responsibility and drastically up their retirement saving using the investment vehicles most appropriate for them.
If you are that rare freelancer with a big profit margin at the end of each month, then a Simplified Employee Pension Individual Retirement Account (SEP-IRA) is a golden tool, advises Denise Kiernan, co-author of "The Money Book for Freelancers, Part-Timers, and the Self-Employed."
The self-employed can set up this version of a traditional IRA themselves. You will reduce your taxable income for your efforts, and the contribution limits are much higher than for traditional IRAs - 20 percent of income, or $52,000 (whichever is less) in 2014. Consult IRS Publication 560 for more details.
If money is tight, a traditional IRA or a Roth IRA will probably give you enough room to save, and might be easier if you already have accounts set up. Each currently offers annual contribution limits of $5,500 (plus an extra $1,000 for people over 50).
The choice becomes whether you want to get a tax break now, with a traditional IRA, or have tax-free earnings with a Roth. You cannot fully fund both at the same time; CPA Medows suggests using a Roth whenever possible.
But with freelance cash so inherently erratic, how can you contribute enough retirement money?
Brooklyn magician Evan Paquette is a fan of personal-finance expert Ramit Sethi's "envelope" system of apportioning percentages of whatever money comes in to different goals, like basic expenses, entertainment, or retirement saving.
Most financial institutions allow you to set up an automatic withdrawal into a retirement account, or they can send you a digital reminder to make a contribution each month or at certain times of the year.
"That way, whether you're making $100 a month or $10,000 a month, money is still getting put towards the retirement goal," says Paquette, 30, who uses a SEP-IRA to house his retirement assets. "Even if it's only $5, at least it's something."
Retirement experts are looking for ways to make this automation easier for non-workplace savers. One idea before Congress now is an "automatic IRA" that citizens would have to opt out of, rather than figure out for themselves.
This has worked well in the United Kingdom, says Shlomo Benartzi, a professor at the UCLA Anderson School of Management and chief behavioral economist for Allianz Global Investors. California has passed such legislation at the state level, although it has not yet taken effect.
Whatever happens to help freelancers start saving, Benartzi says time is of the essence. Since only roughly a third of all Americans are contributing to 401(k)s right now, society has to get freelancers on board, or the retirement-savings system will become even more broken than it already is.
"We don't have to wait to see a retirement-savings crisis develop," he says. "We already have one."