Once upon a time, it was totally reasonable for middle class kids to expect that they would work for one, maybe two employers, and retire at 65 with a watch and a pension, the end. But in recent years, the economy has shifted towards self-employment and freelance work—the gig economy.
The twenty-first century has brought us a rapid-fire series of profound changes. Millennials represent the first generation of Internet culture natives, who grew up using Amazon in place of physical stores; Netflix to supplement or even replace cable TV or movie theaters; and newsfeeds instead of news papers. While technological advances have flourished, jobs and the US economy haven’t done quite as well. As automation has increased and globalization has given access to cheap, if unethical, labor abroad, America’s historically robust manufacturing jobs have dwindled, and the service economy is on the rise.
So what exactly is the gig economy?
Jobs that were once considered secondary – freelancer, consultant, and others – may now be the only income that a worker has. While many people still work full-time while working their “side hustle,” a growing number choose gig employment as their primary source of income. Being employed in this way comes with highly desirable flexibility and freedom, but it also carries the risks such as unstable income and no employer-provided benefits.
Plan for your own retirement in the gig economy
If you don’t work for a company that offers an employee-sponsored 401(k) plan, what should you do? There are several ways that gig economy workers can plan for their own retirement:
Any individual can qualify to contribute to a traditional IRA (Individual Retirement Account), whether they are self-employed or work for an employer. A traditional IRA uses pre-tax income and grows tax-deferred. Any capital gains or dividends are not taxed until the funds are withdrawn.
Benefit of a traditional IRA: you get the tax break now and will be taxed at the time that you withdraw the funds—typically during retirement, and usually, at a lower tax rate.
Any individual can contribute to a Roth IRA—either self-employed or working for an employer, as long as they meet the income qualifications. A Roth IRA uses after-tax dollars, so since you don’t get the tax benefit now, you are able to take advantage of tax-free growth.
Benefit of a Roth IRA: when you withdraw the funds at retirement, you won’t have to pay tax on the capital gains; you may continue to contribute to your Roth IRA even after age 70 ½ as long as you have earned income.
*For 2017, the maximum contribution level to your combined traditional and Roth IRAs is $5,500 (or $6,500 if at or over the age of 50).
A business owner may choose to set up a SEP IRA (Simplified Employee Pension) so they can contribute to their own retirement, as well as any employees that they may have. Even if your business doesn’t have any employees, you still may want to set up a SEP so that you are able to contribute to your retirement at a higher level than a regular IRA.
Benefit of a SEP IRA: low start up and maintenance costs.
*For 2017, the maximum contribution is $54,000, or 25% of compensation—whichever is less.
An independent 401(k) plan, also referred to as an individual or solo 401(k), is similar to a SEP IRA. However, there are several factors that set the Independent 401(k) apart from a SEP IRA: individual contribution levels to an independent 401(k) are much higher than to any of the IRAs; it allows the business owner to take out tax-free loans for $50,000 or 50% of the benefits in the plan, whichever amount is lower; and they offer low maintenance costs and flexibility of investments.
Benefits of an Independent 401(k): offers Roth option for conversion for existing IRAs to be consolidated into your 401(k), as well as a Roth option for the employee deferral contribution.
*For 2017, the maximum contribution is $60,000.
As the economy continues to shift and change, what it means to be employed in that economy will be subject to the same changes. Whether you find that your job is flexible or rigid, you need to make sure that your retirement plan is nimble enough to keep up.
Sources: irs.gov, irs.gov, Forbes.com
Katie Moore, CDFA, a Financial Planner and Certified Divorce Financial Analyst with Finivi, is passionate about empowering savvy independent women, and women in transition due to a divorce, the death of a spouse, a career change, or other significant life event to expand their knowledge and build their confidence regarding money and investing.
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