How to save for retirement if you're self-employed

The number of self-employed workers has been growing since 2000, with today, over half a million Quebecers choosing to work for themselves. For them, retirement planning, especially when it comes to savings strategies, has its own unique challenges compared to salaried workers: the absence of an employer means they do not have access to a pension fund or savings plan; their money often serves as start-up capital and sometimes even as working capital; and often much of their energy is channelled into growing and making their business profitable.

Nevertheless, it is still essential to have a sound retirement plan and to save for your later years.

To better understand this reality, we asked David Decary, CPA, an expert in financial management at the École des entrepreneurs du Québec, to share with us his top tips for self-employed workers who wish to save for retirement.

Savings for retirement when you're self-employed

When should you begin to save?

When first starting out, self-employed workers rarely make saving for retirement a priority. "You are instead focused on just surviving until the next day and are counting on growth over the medium term. However, it is critical to start saving as soon as possible!" declares David Decary at the outset. Even once your business is set up and you're well established, each year counts; and even small amounts set aside regularly can make all the difference.

For example, $100 saved each month for 20 years at an annual rate of 5% would amount more than $40,000 in savings. "And within 30 years, it would be worth more than $80,000. You thus double your capital over a 10-year period! Whether the savings are large or small, it is important to invest your money as soon as possible using all the financial products available to you, such as RRSPs, TFSAs the Québec Pension Plan and stocks," he adds.

What do you do if you have debt?

When you go into business for yourself, it's not uncommon to take on new debt or carry past debt. Some may be tempted to repay this debt in full before starting to save. "This could hurt you in the long term," insists the financial management expert. You need to distinguish between good debt, such as a mortgage, which often comes with a low interest rate and a generous repayment term, and bad debt, which can have a fairly high interest rate. Advisor David Decary is all for "repaying toxic financial products first such as credit cards and personal lines of credit that charge high interest rates. They cost you more than what you would receive if you invested." As a rule of thumb, he suggests you first pay off financial products charging over 10%-12% in interest as quickly as possible and then make saving a priority.

What investment vehicles should you choose?

Traditional investment vehicles are available to both self-employed workers and wage earners. The best choice, however, can vary widely depending on whether you choose to pay yourself a salary or opt for company dividends. For example, if you choose to issue yourself dividends, you will likely be unable to contribute to an RRSP, according to David Decary, since you have to earn a salary in order to be eligible to participate. His recommendation: "The TFSA becomes the solution of choice, since it allows self-employed workers to invest and benefit from tax-free gains. You can set up your investments so that any interest earned is reinvested, which will quickly add up to a tidy amount of investment capital." Building up savings within a TFSA also allows you to have a certain amount of liquidity on hand to support your company through growth phases. However, if you pay yourself a salary and the company is fully independent financially, the RRSP is the best savings solution for you.

RRSPs for self-employed workers

For a self-employed worker who pays their own salary and runs a business that's financially self-sufficient, an RRSP can offer many benefits. It's also a very attractive savings vehicle for those interested in reducing their taxable income, buying a first property, or planning for retirement. Automatic savings can be an effective tool for taking advantage of the tax benefits of an RRSP and meeting your financial goals. All you have to do is budget an amount you can contribute each month without causing financial stress.

To determine a realistic savings amount, you can calculate the average of your annual RRSP contributions over the past three years and divide that amount by your desired withdrawal frequency. You'll find that, by saving regularly throughout the year, your contributions will be easily incorporated into your living expenses. To save $2,500 a year, for example, you would need to contribute about $48 a week.

How much should you save?

As David Decary points out, it is important for the self-employed worker to understand that they alone are responsible for saving for their retirement, for the simple reason that they are the only one setting money aside. "When you are employed, the employer also contributes to the Quebec Pension Plan, or QPP. So without that additional savings source, you need to bump up the amount you put away to match the amount workers are savings," he explains. An employee who contributes the maximum amount allowed under the Quebec Pension Plan must save an additional 15% of their salary if they wish to maintain their living standard during retirement. Without the QPP, a self-employed worker with the same goal must consequently set aside 20%-25% of their income. However, it is also true that self-employed workers do not have as many deductions at source as an employee does, which represents a great savings opportunity!

How can you successfully manage your business while planning for retirement?

Finding the time to manage your investments and savings yourself is of course a challenge when you need to devote most of your energy to running and building your business. David Decary highlights several support options, however, that are available to you. "With the assistance of a financial advisor or thanks to mobile investment apps such as Wealthsimple or Hard Bacon, it's easier than ever to grow your money, even with small amounts."

Establishing an annual savings goal based on anticipated income is also a great way to set up retirement savings within your company's financial structure. By saving a certain amount every week, every two weeks, or every month, you can spread out your savings over the course of the year. This allows you to also monitor your income versus savings and to determine whether you are on track to reach your goals. This then makes it easier to adjust your expectations or even increase your savings to offset any future drops in revenue.

The pitfalls to avoid to make saving for retirement easier

1. Not taking advantage of the QPP fully.

Some self-employed workers choose to issue themselves only dividends rather than a salary in order to avoid paying certain contributions such as the QPP. According to David Decary, however, earning a salary of $68,500 would mean you could contribute the maximum amount to the QPP in 2024. This would then allow you to benefit from a maximum, guaranteed and indexed pension, regardless of market fluctuations. He regards this as an excellent tool to diversify risk and income during retirement.

2. Putting all your savings in your company.

Relying solely on your business and investments to save for retirement carries inherent risk. "Your company is a business vehicle that is relatively fragile. A lawsuit or an accident could wipe out all your savings. Putting all your retirement eggs in your business basket is highly risky," he emphasizes. Instead, he favours a mixed strategy in which you place a part of your dividends and salary in a range of investments as part of your personal finances, taking a conservative view of any future withdrawals from the company.

How the Quebec Pension Plan works for self-employed workers

"It's quite simple, really," starts off David Decary, "as soon as your income exceeds $3,500 in a fiscal year, you must contribute 12.8% of your income. You can find all the details on the website of Retraite QuébecAttention, this link will open a new tab.. And you make your contributions at the same time as your tax instalments." He reminds us, however, that self-employed workers who opt to pay themselves dividends are not required to contribute to the QPP, since these contributions are collected on salaries only. Moreover, they will also not benefit from any pension benefit when they retire.

The best retirement game plan for self-employed workers

David Decary concludes with a summary of the strategies for the best game plan to save for retirement and ensure you can enjoy the quality of life you are accustomed to.

• Think about allocating 20%-25% of your income to retirement savings.
• Begin to save as early as possible, even small amounts.
• Increase your retirement savings once you have finished paying off your high-interest debts.
• Maximize your QPP contributions in order to diversify your income sources during retirement.
• Divide your retirement savings among your personal and business finances.
• Benefit from the assistance and investment advice of a financial advisor.
• Review your game plan from time to time as your business grows.

The great appeal of being self-employed and launching your own business is that you alone call the shots and decide for yourself what projects you pursue. Don't forget that retirement is also a key part of the adventure!