Independent Contractor vs. Employee: How to Make the Most of Your Retirement Investments
If there’s one thing that’s been easy to see in the past few years, it’s that there has been a huge shift in workplace culture. The increase in remote employment, normalization of wage discussions, workforce empowerment, and more have all resulted in radically new ways of thinking about work and the role careers play in the lives of young professionals.
These changes may have inspired you to make some major career choices of your own. If you’ve recently made the switch from being an employee to a self-employed professional, or even started your own side hustle, you might be wondering how that affects your options for retirement savings and investments. The good news is, you have plenty of possibilities.
Traditional Independent Contractor Retirement Options
While there are several retirement choices available to self-employed individuals, here are two that are quite common and the investment options that come with them:
The Solo 401(k)
The Simplified Employee Pension Individual Retirement Account (SEP-IRA)
The Solo 401(k)
If you’re looking for an alternative to the typical employee-sponsored 401(k) plan as an independent contractor, you may want to consider setting up a solo 401(k). A solo 401(k), also known as an individual 401(k), is a retirement plan designed for small business owners who are self-employed and have no other employees beyond their spouse.
Even if you’re a full-time employee with a side hustle, you can still open a solo 401(k) alongside your employer-sponsored retirement plan. As both the employer and “employee” of your side hustle, you can actually “double” your contributions to the solo 401(k), as well as maximize your contributions to the employer-sponsored 401(k).
Solo 401(k)s are available as both a traditional and Roth option, so you have the flexibility to choose the option that is best for your future retirement needs. Additionally, in 2022, solo 401(k)s have an annual contribution limit of $61,000—or $67,500 if you’re over the age of 50.
It’s relatively easy to set up a solo 401(k), although it’s important to remember that you will need an Employer Identification Number to do so. You cannot open a solo 401(k) if your business employs anyone other than yourself and your spouse.
The Simplified Employee Pension Individual Retirement Account (SEP-IRA)
A Simplified Employee Pension Individual Retirement Account, or SEP-IRA, is another popular option for independent contractors. Self-employed individuals, with or without employees, can open a SEP-IRA, which is known for being relatively easy to set up and maintain.
Many people opt for SEP-IRAs because they allow you to contribute much higher amounts than a traditional IRA. You can also open a SEP-IRA as a small business owner if you have employees—although there are specific rules about employer contributions that need to be followed.
Another positive of SEP-IRAs is they allow employers to pause their contributions if their business is not performing as expected. It should be noted, however, that unlike with a 401(k), you cannot take out a loan from your SEP-IRA.
Growth Assets vs. Income-Producing Assets
The most common retirement plans, whether employer-sponsored or self-employed, only allow you to invest in traditional asset classes such as stocks, bonds, mutual funds, and ETFs. Outside of these asset classes, your options are limited.
Most traditional asset classes are considered growth assets. The value of growth assets is usually tied to the long term due to the tendency for markets to rise and fall over time. Due to historical performance data, growth assets are generally expected to have good returns if you keep your funds invested long-term.
Growth assets, however, must be sold to be used as income and require enormous amounts of capital to produce enough income from returns over a long-term retirement period. For many people, saving a large enough nest egg into a 401(k) simply isn’t feasible to produce the income they need in retirement.
Income-producing assets, on the other hand, have the potential to produce reliable positive cash flow even during the investment holding period. While some traditional asset classes, such as dividend stocks, can produce income, many alternative asset classes are more likely to produce reliable income on a monthly or annual basis. Some of these alternative assets include real estate, peer-to-peer lending, equipment leasing, private equity, and more.
Alternative Retirement Accounts for Independent Contractors
While traditional retirement options provide limited investment choices, there are investment options beyond typical stocks and bonds that may be worth looking into for a successful independent contractor like yourself.
Most people assume that they can only invest in alternative, income-producing assets with post-tax dollars. In other words, they think they can’t use tax-advantaged retirement savings to invest in alternative assets.
Fortunately, this is not the case. A self-directed IRA (SDIRA) is an individual retirement account that allows investors to purchase asset classes outside the options offered in regular retirement accounts. This makes SDIRAs a great option for creative investors who know there are better ways to create income for retirement.
Benefits of Investing in Both Traditional and Alternative Assets
With there being good and bad characteristics of both traditional and alternative asset classes, it’s valuable to invest in both. Some benefits of investing in both traditional and alternative asset classes included:
Diversification
Creativity
Increased opportunity for wealth
1. Diversification
Investing in both traditional and alternative asset classes allows for significantly more diversification in your investment portfolio. The more diverse your portfolio is, the less overall risk you face, which can be key in setting yourself up for financial freedom in retirement.
For example, if stocks and bonds are down in a given year, investors may be able to rely on income from their real estate investments until the market stabilizes. Relying on income from multiple investment sources can allow retirees the peace of mind that comes from knowing they’ll be less likely to have to sacrifice their lifestyle in volatile years.
2. Creativity
While traditional investments do have a place in all retirement savings strategies, alternative assets allow you to invest in things you know and care about. With an SDIRA, you can invest in projects that allow you to be creative and solve problems.
So if you’re passionate about refurbishing or flipping run-down properties, you can invest in real estate projects and know that you’re providing people with cleaner, safer, and more pleasant homes to live in. If you enjoy helping innovative start-up companies streamline their processes and market their products or services, you can invest a portion of your retirement savings in private equity. With an SDIRA, your investment opportunities are essentially limitless.
3. Increased Opportunity for Wealth
Although traditional assets are tried and true, non-traditional investments have the possibility of building wealth much faster—and even more sustainably in the long-run.
Of course, any investment comes with its own inherent risks. But investing in projects and assets with more opportunities for growth may allow you to achieve a more comfortable retirement with less capital over the long-term.
Ideally, making use of both options allows you to minimize the risk associated with less traditional investments, while also generating both current and future retirement savings.
How Chicago Trust Administration Services Can Help
Expanding your retirement investment options can be beneficial to your future financial security. However, IRS regulations for SDIRA investments can be complex. You need a knowledgeable, fast SDIRA administrator to make the transaction process seamless and headache-free.
At Chicago Trust Administration Services, we take care of IRS compliance regulations so you can focus on researching, purchasing, and managing the investments for your best financial future. To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.