MARK RIEPE: I'm Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decision-making and the cognitive and emotional biases that can cloud our judgment.
In this episode, we're talking about people who work for themselves and the challenges they face in their financial lives—especially how they can save for retirement.
To narrow the scope a bit, we're not talking about small-business owners, but instead we're talking about a group of people often referred to as "freelancers" or "contractors."
Those terms are similar, but not identical, but to keep things simple in this episode, I'm going to be referring to "freelancers."
By the way, that name originally referred to soldiers for hire.
In medieval times, soldiers fought with lances, hence the term "free lance."
If you're of a certain age, you might have been forced to read a book in high school called Ivanhoe by Sir Walter Scott. Published in 1819, it contained the first written reference to a "free lancer."1
I'm going to go out on a limb and speculate that, today, most freelancers are not, in fact, mercenaries.
According to the job site Indeed.com,2 freelancers are better described as people working for several clients, taking on several projects at once, and depending on the job, choosing where they work—from home or a coffee shop, for example.
Freelancers have near-complete control over their schedules and often can decide when they work, as well.2
They may set their own pay rate. But sometimes they work through an agency that sets their rates. They may charge by the hour or the project.4
The number of clients a freelancer has varies, as does the number of projects. They can be short-term one-offs or take months or years to complete. Freelancers can work for the same client for years, as well.4
Some typical professions for freelancers are journalists, marketing copywriters, graphic designers, and programmers.
If you thought that this type of work was a fringe part of the labor market, you would be wrong.
The freelance world is huge and growing. According to estimates, the number of freelancers in the United States in 2014 was 53 million.3
That's already a big number, but a survey conducted in July of 2023 estimates there are now 73 million freelancers, and that number is expected to reach 90 million by 2028.4
Freelancers make up around 37% of the U.S. workforce, with earnings of $1.3 trillion per year.5
Not surprisingly, the younger the worker, the more likely they will freelance, but what did surprise me was that 26% of Baby Boomers freelance as well.6
Freelancing obviously appeals to a lot of workers and offers a lot of benefits. But it doesn't offer a 401(k) program, and that means saving for retirement is not as easy as filling out a form and giving it to HR.
In fact, freelancers essentially are their own HR department, and that adds some complexity.
To help explain the options, Susan Hirshman is here. She's been a guest on the show before, and I'm glad she could join me again.
She's a director of wealth management for Schwab Wealth Advisory and the Schwab Center for Financial Research.
She's also a Chartered Financial Analyst, a CERTIFIED FINANCIAL PLANNER™, and has worked for many years as an advisor to high-net-worth and ultra-high-net-worth investors.
MARK: Susan, thanks for being here today.
SUSAN HIRSHMAN: Great to be here, thank you.
MARK: Most of the episodes we do on the show, you know, sort of implicitly assume that people have jobs where they're getting a steady paycheck, but we've got a lot of people who are really kind of working for themselves. And for those folks, kind of the financial aspects of their lives can be inherently more complicated because of that. And so one issue I wanted to ask you about is—before we get into some of those details—the idea of retirement itself. I suspect that for many people who, you know, they're working for themselves, or they've got a flexible schedule, they don't really envision themselves stopping work completely at a particular age. Are you seeing any kind of trends along those lines when it comes to, you know, entrepreneurs or freelancers in terms of how they view retirement?
SUSAN: Well, you know, as I don't have to tell you, Mark, what people want their retirement to look like is so very personal and really dependent on who they are, their wealth status, their family circumstances, their personalities, and on and on. But it's interesting when you look at the freelance community, 26% of Baby Boomers are freelancers, and 30% of Gen Xers are freelancers.
And as I mentioned before, those percentages are only growing. So we're seeing more and more very experienced people coming into the freelance pool. And especially those people who really enjoy what they do, they're not ready to leave their industry completely, and they have strong networks where they can apply their skills. I'm not seeing them necessarily retiring 100%. Instead, a term I hear being used among these kind of retirees is that they have a "portfolio of opportunities."
MARK: Yeah, I like that term a lot. Give me some examples of what that looks like in practice.
SUSAN: Yeah, so a client that I worked with in the past, he sat on several mid-market manufacturing company boards. He worked on various consulting projects as they came up during the year, but never during the summer, and taught a class at a community college. So he said he was going to continue doing this until it just wasn't fun anymore.
And then another client who retired, and then she got really involved in a charitable organization. She was a great strategic planner and manager. And when the CEO was asked to leave, the board basically said to her, "You're doing all the work of a CEO. Would you be interested in coming on board?" And she agreed as though she thought she might as well get paid for her expertise and thought it would be a great way to add to her legacy pool. However, she stipulated that she would only agree to a five-year plan. And during that five-year plan, she was going to focus on creating a really strong succession team.
MARK: Yeah, those are great examples. And when you think about saving for retirement in whatever form it takes, you've talked before about three C's, namely convenience, cash flow, and complexity. Tell me a little bit more about what you mean by those, and why don't we start with convenience first?
SUSAN: Yeah, so when you're an employee, you pretty much have one choice—your company 401k plan. It's all set up for you, and plans today have a lot of "do it for me" options where they have auto enrollment, auto escalation of contributions, and so on. So it's really fast and easy.
However, when you are a freelancer, especially initially, it takes some time. It takes effort and some analysis to decide which plan is right for you and how much you want to contribute. So unfortunately, that often leads to procrastination. I can't tell you how many times I heard the statement "I meant to, but I was just a little too busy to focus."
MARK: Yeah, I think we've all heard that, and frankly, probably said it ourselves if we're being honest. We're going to get to procrastination a little bit later, but before we do that, tell me a little bit more about cash flow and complexity. Why can those be problems for freelancers?
SUSAN: Yeah, so as you can imagine with freelancers, their cash flow can be really lumpy, meaning that they can have great earnings some months or even some years and perhaps lighter earnings at other times. So often people get the feeling that they may not be able to afford to save for retirement, and they want to wait until that perfect time, which often comes way down the road if it comes at all. And then complexity, as we mentioned, you have to choose, and there's a variety of ways to save for retirement as a freelancer. And again, knowing what the right plan for you is takes education, it takes analysis, and oftentimes advice from an expert.
MARK: All right, so let's imagine the individual. They've decided, yes, they need to start saving. How do they go about really getting started? You mentioned that their problems are procrastination. Well, what do they need to be looking for to kind of get them off the hump?
SUSAN: You know, I think to get off the hump, you have to say to yourself, "Progress versus perfection." As I mentioned before, people really hesitate to start saving because they feel it's all too complicated, but it doesn't have to be. And the key is that it can evolve over time.
So here's an example. Let’s say we start really simply with a regular IRA or a Roth IRA, and then as your business grows and as your income grows, then you can look to other plan types where there's opportunity to save more. So let's say we started with an IRA. You can save $6,500 for 2023, an extra thousand if you're over 50. And so that's pretty good when your income is low. And over time, when your income grows, you can start a solo 401(k) plan, for example, where you can contribute up to $66,000 for 2023 or $73,500 if you're over 50. So big differences can occur. So evolution is the key.
MARK: So after they've opened the account, and they've made that commitment to prioritize saving for retirement, how do they know how much to save each month or each quarter? You already alluded to the fact that their cash flows can be lumpy.
SUSAN: Yeah, and I have to say, I love that terminology you just used, commitment and prioritization, because that's really where it starts. And people always have to keep in mind that saving today for tomorrow, you are in essence giving yourself a gift for the future by depriving yourself perhaps of some discretionary spending.
And so that's the first step in any retirement plan is to mentally commit to saving, get really connected to the fact that your future is a priority, and really focus and use resolve. And then once you have that connection and you're committed and you're prioritized, then it's time to get into the numbers.
So when we get into the numbers, just lay out your spending plan. What are your fixed expenses? Housing costs, student loans, health insurance, estimated tax payments, and so on. And then what are your discretionary expenses? Entertainment, travel, gym memberships, Netflix subscriptions, and on and on. And then you have to see. So how does your spending plan line up to your net freelancing income? Is there excess? And if there isn't, what discretionary expenses can you reduce so that you're able to save today?
The bottom line is—the earlier you can start saving, the more your money can work for you. So get your money working for you early. This way you can have choices later on. And it's easy. You can use an online retirement calculator like you can find on Schwab.com to determine a savings estimate, or if you need help, work with an advisor to create a plan of action.
MARK: So let's talk a little bit about some of the incentives that are out there to make this a little bit easier for the individual. You know, the federal government has created—we're going to talk more about accounts a little bit later—they've created special types of accounts. They've also created things called the Saver's Match and the Saver's Credit. So explain what those are and how they differ from each other.
SUSAN: Yeah, so the first thing to understand, as you mentioned, is that they're both government-sponsored programs. So that always means a little bit of complexity. So there's rules, there's limits to be aware of. And these plans are really meant to help people who are lower earners. So you have to qualify, and there's income levels for those people.
And the second thing to keep in mind is 2027. And that is when the Saver's Credit is going to be replaced by their Saver's Match. And that happens because of the Secure Act 2.0, which was enacted in 2022. And there's three key differences between the credit and the match. The first is the way you get it. The credit is reported on your tax return and reduces your current income tax liability dollar for dollar. Whereas the match is an actual deposit of funds into your retirement account. The second is you get the match with or without a tax liability. Whereas with the credit, you only get a benefit if you have a tax liability to reduce.
Third is the calculations and the limits. They're slightly different. As the credit has different credit amounts that are based on income levels, the match doesn't. I really believe that the Match can be really effective as many people don't even realize that that credit exists. I saw a recent stat that stated only 41% of people who qualify for the credit know about it and use it.
And so hopefully by directing money into one's retirement count, it can really be a boost to retirement savings.
MARK: Susan, I wanted to ask you a little bit about different account types. And I know it can be overwhelming for some people, because as they'll hear just in a couple seconds here, there are a lot of different options. So let's start with the one that I think is one of the most powerful ones, and that's the defined benefit plan. A lot of people don't even realize that's available to freelancers. So what is the defined benefit plan, and how does it work?
SUSAN: Yeah, a defined benefit plan is used when people want to maximize their contribution to a retirement plan. And as the name implies, the goal of a defined benefit plan is to give you a predetermined—that's why it's called defined benefit—think pension plan. And a few things to keep in mind when thinking about a defined benefit, or what we like to call a DB plan.
So first, a DB plan—it's the most complex plan, and you really have to be committed to it, as it has to be funded annually.
A defined benefit plan also requires the services of an actuary to determine the contribution amount.
And then third—a good rule of thumb for those who are a good candidate for a defined benefit plan is really someone who's over age 50, who can make annual contributions of $90,000 for more than five years.
So put simply, a defined benefit plan is really for people who are making significant income, looking for a way to really increase their retirement assets and are open to administrative requirements and costs.
MARK: Next up is the 401(k). So a lot of people are familiar with 401(k)s through their employers, because those actually have driven out actually a lot of DB plans for employers. But freelancers or individuals can open those up too, right?
SUSAN: Yeah, but they're called solo 401(k) plans or individual 401(k) plans. And the key why they're called solo is that you cannot have any employees except your spouse. And so solo 401(k) plans, contribution amounts, costs, administrative fees tend to be less than defined benefit plans because they're less complex, but slightly greater than SEPs, SEP IRAs. The contributions, the limits, all these things can be found on Schwab.com under Small Business Retirement Accounts. And another interesting thing about a solo 401(k) plan is that, unlike a defined benefit plan, contributions are not required every year. So it gives you a little bit more flexibility.
MARK: Yeah, I think that makes a lot of sense probably for many people. You mentioned SEP IRAs there. Which IRA should self-employed people consider?
SUSAN: Yeah, there are a few different IRA types. There's an IRA, a Roth IRA, a SEP IRA, and a Simple IRA.
So let's cross out the one that's not applicable first. And that's a Simple IRA because it's for businesses up to 100 employees. So freelancer, most likely not of interest.
The SEP IRA is going to allow you to make much higher contributions than a regular IRA. But however, you should keep in mind, if you start to have employees, you're going to have to contribute to those employees' retirement plans as well. And also SEPs, unlike solo 401(k) plans, don't allow catch-up contributions for those over 50, and they don't allow loans like a solo 401(k) Plan. And prior to 2023, SEPs did not have a Roth option, which solos now do.
So it's really about what is important to you, what is your future going to look like? Are you going to have employees? And so the bottom line is every situation is different, and an individual should really assess the option that is best for their financial goals.
MARK: All right, so we figured out the importance of savings. We talked about that. We figured out how much you're going to save. You've got to open the account, and a lot of different choices there. The next step is selecting the actual things to invest in within these accounts. So what are some of the general guidelines for investing then in these different accounts?
SUSAN: Yeah, the general guidelines for investing in these various plans is, you know, the younger you are, the more aggressive you can be, meaning the greater allocation you can have to stocks versus bonds and cash.
But you know, the goal of long-term investing is to stay with your plan. So just because your age says you can be very aggressive, if major market downturns would make you panic, bring you great discomfort, make you make some really unwise moves, you may want to temper your allocation to fit more about who you are and what will make you stick to your plan.
And also at Schwab, when we think about investing, we really believe that besides your asset allocation, one of the key drivers of performance is cost. So when we look at investment solutions, we are always having a focus on how does one compare to the other, and what is the low-cost solution.
MARK: We've talked about many times on different episodes of the show about how it's really important not to be kind of foolishly optimistic. And you always got to think about what could go wrong and prepare for different types of risks. So for those who are self-employed, what other sorts of risks are out there that they need to be aware of when it comes to financial planning?
SUSAN: Yeah, and one of my favorite sayings is "Expect the unexpected." And so with that in mind, here are some things that I think you should think about.
Illness, right? What happens if you can't work? Do you have an emergency fund to cover those near-term expenses? Or what happens if it's a more serious illness? Do you have a disability insurance in place?
And then, what type of freelancing are you doing? Is it professional services? And what happens if you make a mistake that costs clients money? Are they going to sue you? So do you have professional liability insurance in place?
Or in this day and age, what happens if your business has an online presence and you have a data breach, or you're hit by ransomware or another form of cyber-attack? How are you going to protect yourself? Do you need cyber liability insurance?
And lastly, what happens if you accidentally damage a client's property? Do you have general liability insurance in place?
The bottom line is that, again here, you need to assess your situation, assess your risks, and obtain appropriate coverage to protect yourself from the unexpected.
MARK: Yeah, I think that's absolutely right. I want to finish up with a handful of questions about taxes, not so much about kind of account types, but other dimensions of tax differences for freelancers. And I can imagine that it can be easy to merge kind of your personal spending and your business spending as a freelancer. So what suggestions do you have for people to help differentiate that spending, especially when it comes to tax time so it's a little bit easier to file those forms?
SUSAN: That's such a great and important question. And there's a few things that you should consider.
First is credit cards. It's best to have one that you use only for your business and a separate one that you only use for personal.
And then secondly, open a separate checking account to be able to keep track of the income coming in and the expenses going out, especially since you have to pay estimated taxes. Now you have a place to hold some money back from your personal checking account so you don't have to avoid any late payment penalties and so on. I can't stress this enough. One study showed that 33% of self-employed workers say they are behind in paying their estimated taxes.
And the third is a calendar. Keep a detailed calendar that shows what days you worked, the hours, the location. In other words, really good record keeping. Use apps. There's an app I know that exists that helps with mileage tracking if you do a lot of driving for business.
And the reason all this record keeping and the separation is so important is really about in case you ever get audited. You want to be able to ensure that you are properly accounting for income and expenses and that you can easily prove your business activity.
MARK: Yeah, I think at the end of the day, you are operating a business, and that kind of occurs to me that there are a lot of different structures that you can set up your business as and … how should a freelancer be thinking about that? What are they? What are the common ones, and what are some of the differences?
SUSAN: Yeah, and I think it comes down to three things when you think about what type of structure I have. One is your timeframe, two is the type of services that you're delivering, and three is your personal balance sheet.
So here's what I mean. If you're going to freelance for a year or so—perhaps you provide graphic art services and you're just starting out—then the question I have is, do you need to go through the cost and filing requirements to be more than a sole proprietor? And can you just record your business activity on a Schedule C of your income tax return? Are you putting a lot at risk? Whereas if you plan on doing it for a longer term, if you're offering more advice or professional type of services, and you have significant personal assets, you may want to consider shielding yourself from potential personal liability that may arise in the future. Then you may want to consider using different types of business structures.
A really common structure is an LLC. An LLC is the legal entity that is separate from the owner in the eyes of the law. And what does that mean to you? It means that the LLC is held accountable for its actions, not you personally. And establishing an LLC, comparatively speaking, is a pretty simple process.
Another similar, but slightly different, structure with a more complex process is what's known as the S-Corporation. Both of these have specific nuances, and it's really best to talk with a CPA before taking action.
MARK: Final question, and that is the self-employment tax. I hear a lot of people kind of complaining about the complexity of this. What are they talking about? What's the issue here?
SUSAN: Yeah, and it's not even the complexity. It's just the fact that people have to pay it that we hear people complain about. And really it's because how self-employed people are paying into the Social Security and the Medicare system. If you're an employee, it's automatically deducted from your paycheck. But here you have to pay it outright. And a big difference between self-employment tax and those payroll taxes that come out of an employee's paycheck is that, when you work for somebody, employees and employers split the bill on Social Security and Medicare, meaning you pay 7.65% and your employer pays 7.65%. Self-employed people, they pay both. But the good news is that it is on net earnings. So income less your expenses. And many websites, again, have calculators you can use to estimate what you would look like.
Also, it may not be intuitive, but people should keep in mind that half of your self-employment tax is considered a business deduction. And you pay this tax through your quarterly estimated taxes. In other words, those quarterly estimated taxes include both income tax and self-employment tax. And for many, I know self-employment tax can seem like a burden, but what you're doing is hopefully paying into a system that will be there for you when you retire.
MARK: Susan Hirschman is the director of wealth management for Schwab Wealth Advisory and the Schwab Center for Financial Research. Susan, thanks for being here.
SUSAN: Thank you.
MARK: It takes a certain kind of worker to choose to freelance.
Of course, some of us are forced into it due to shifting employment situations. But plenty of people enjoy the freedom, flexibility, and control that comes with being a freelancer.
That got me to thinking—what type of person is more likely to be a freelancer? Do they share certain personality traits?
In a survey that examines what are known as the "Big Five" personality traits in freelancers and permanent employees, we found some hints.
For context, the Big Five traits were developed from the work of various researchers going back to the 1930s. The term "Big Five" was first used in 1981 by Lewis Goldberg.7
Researchers developed personality tests, much like Myers-Briggs, to determine how much of each trait a person has.
Here are the traits, and the first letters of each spell out "OCEAN."
O is for "openness" to experience, which is about intellectual curiosity and creative imagination.
C is for "conscientiousness," which involves organization, productiveness, and responsibility.
E stands for "extroversion," which as you might suspect refers to sociability and assertiveness, and its opposite, no surprise here, is introversion.
A is for "agreeableness," which measures compassion, respectfulness, and trust in others.
Finally, N stands for "neuroticism," which encompasses tendencies toward anxiety and depression.
One survey6 estimates that freelancers are 18 percentage points more extroverted than traditional workers. Freelancers scored 57% versus 39% for workers.
The survey indicated that extroverts tend to stay more positive and are good at verbal and nonverbal communication. These characteristics are important for someone who has to interact with clients, compete for projects, and potentially make presentations.
The second trait where freelancers scored markedly higher than traditional employees is openness. Freelancers are 16 percentage points higher. That's 70% versus 54%.
Recall openness is a measure of intellectual curiosity and creative imagination.
On the other hand, traditional workers scored 17 percentage points higher for neuroticism than freelancers—75% vs. 58%.
In this survey, the researchers point out that neurotics are sensitive to environmental stimuli and will often get stressed about minor events such as whether an email was perfectly worded.
That's not an ideal trait. But neurotics are also prone to exceed expectations and assume more personal responsibility.
This survey went on to ask other questions about the workforce. For example, it found that freelancers say autonomy and flexibility in their work is important to them, which is what you'd expect.
They had the same levels of job satisfaction as traditional employees, but 62% reported a high level of work-life balance, as opposed to 55% for traditional workers.
I started this segment by mentioning that not all freelancers do it by choice.
That's true, but it is the exception rather than the rule. 75% of freelancers said they were freelancing by choice.
And since this is a show about money, we also learned that those who do it by choice earn an average of $20,000 more per year than those who freelance out of necessity.
It is time for the What's New? segment.
I think it was the last episode when I was talking about how some Olympic athletes use visualization—or imagery training—to improve their performance in competition.
In that same episode I repeated the suggestion I've given people many times that it's important to have a clear picture of your financial goals and what you want your future to look like so you can make good decisions about how you'll pursue those goals.
After that episode was wrapped up, we came across an interesting study from Polish scholars that was published this past June.7
In the study people were asked to read descriptions various real life risky activities. By that I mean they were asked to think about taking strong medication without consulting a doctor, betting a year's salary on sporting events, investing 10% of your income in a growth stock fund, and several others.
They were then asked to create three different vivid images of themselves being involved in that activity and then rate whether each image was positive, negative, or neutral.
After that was done, the participants were asked how willing they would be to engage in the risky activity.
If the images they saw in their mind's eye were positive, they were more willing to take the risk, whereas negative imagery made them less willing.
Let me give you an example: One prompt was driving fast on a winding road in the mountains, to which many participants imagined positive experiences.
If all went well, it could be fun. As a result, people were more willing to take this risk compared to those who visualized negative outcomes.
This study is intriguing because it shows visualization isn't just a tool for Olympians and highly paid athletes—it can be used when evaluating common everyday-type decisions that we all frequently face.
To quote from the study itself, "[E]nvisioning the future using visual imagery may be considered a 'mental tool' in the decision-making process in real-life situations."
It's important to remember that the point of visualization isn't to influence you take more or less risk in these decisions. The point is to get you to slow down and think through both the positive and negative consequences and then make an informed decision.
When I was a kid, I did something stupid, and I think my Mom said to me something like, "Well maybe you should've looked before you leaped."
Of course, she was right—as she was about 99% of the time. So listen to your mother and create those vivid images of the future when facing a decision.
And if you can't come up with enough good positive and negative images related to a decision, then talk to a friends or family members or even a financial advisor.
That's it for today. I'm Mark Riepe, and to hear more from me, you can follow me on my LinkedIn page or on X.
If you've enjoyed the show, please leave us a rating or review on Apple Podcasts.
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If you know someone who would enjoy this episode, feel free to share it with them.
Thanks for listening.
1 "The Surprising History of 'Freelance'," merriam-webster.com, accessed October 27, 2023, https://www.merriam-webster.com/wordplay/freelance-origin-meaning
2 Indeed Editorial Team, "Freelancer vs. Independent Contractor: What's the Difference?" indeed.com, updated March 10, 2023, https://www.indeed.com/career-advice/finding-a-job/freelance-vs-independent-contractor
3 Calvello, Mara, "54 Noteworthy Freelance Statistics for 2023," g2.com, September 26, 2023, https://www.g2.com/articles/freelance-statistics
4 Ruby, Daniel, "58+ Freelance Statistics 2023 (Infographics and Trends), demandsage.com, July 27, 2023, https://www.demandsage.com/freelance-statistics/
5 "Big 5 Personality Traits," Psychology Today, accessed November 2, 2023, https://www.psychologytoday.com/us/basics/big-5-personality-traits
6 "Top Personality Traits of the Most Successful Freelancers," skynova.com, accessed October 31, 2023, https://www.skynova.com/blog/top-personality-traits-of-successful-freelancers
7 Smieja, J., Zaleskiewicz, T., Sobkow, A., & Traczyk, J. (2023), "Imagining risk taking: The valence of mental imagery is related to the declared willingness to take risky actions," Journal of Behavioral Decision Making, 36(4), e2340. https://doi.org/10.1002/bdm.2340
