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Gig Workers Saving for Retirement – What’s in Their Best Interest?

Gig Workers Saving for Retirement – What’s in Their Best Interest?
February 13
00:03 2018

With the senate talking about ways to help gig economy workers save for retirement, it’s a good assumption financial professionals are already on it. “Obviously, if gig workers are close to full time and plan to pursue ‘freelancing’ indefinitely, they need some form of retirement plan,” says William Seavey, owner of Crisis Response Publishing in San Luis Obsipo, California. “I think ‘employers’ like Uber and Lyft and those in other fields will likely be acquainting their dedicated workers with them soon if they haven’t already, so that’s a partial answer.” Of course, there’s another question independent workers need to first answer.

The form of business entity controls many factors when it comes to saving for retirement. The new tax law may have subtly changed the calculus, with partnerships expected to revisit their current retirement plan set-up or looking into it for the first time. Most freelancers, however, have stand-alone business structures. Being the sole employee within their operation, they have long benefited from certain structural advantages in terms of retirement saving. Their choice of legal structure can impact those advantages.

Even one-person firms have a wide selection of organizational options when establishing their business. Both the expected income and the anticipated retirement plan preference can influence which structure the worker chooses. In addition, the new tax law may tilt the owner one way or another. “A Limited Liability Company (LLC) permits all retirement plan options,” says Jeff S. Vollmer, Managing Principal at Hyde Park Wealth Management LLC in Cincinnati, Ohio. “It is structured as a pass-through income entity, providing for a simplified and flexible tax structure.”

Depending on potential exit strategies, the owner may prefer to formally incorporate the business. “Depending on the level of income,” says James M. Matthews, Managing Director at Blueprint, a financial planning firm in Charlotte, North Carolina, “an S-Corp can have advantages in that some of the businesses profits can be taken as an owner’s distribution which may provide tax advantages, as well as providing limited liability to the owner and the ability to add additional shareholders through the sale or gift of stock.”

For newer businesses and businesses with young owners, the sole proprietorship represents the structure most often picked. Indeed, for some industries, this is the standard form. “I’d say the most common sole proprietorships that I come across are independent consultants working in the entertainment industry here in Los Angeles,” says Patrick Dinan, president of Impact Fiduciary in Los Angeles, California. “I come across a lot of artists, writers, musicians and TV/Film producers.”

For all the current talk about the “gig” economy, these types of jobs have long had a place in our economy. The term “moonlighting” dates from the 1950s (in this context) and refers to part-time jobs that offer an opportunity for a second income. But these part-time “gigs” could also include more sophisticated positions. “We do quite a few plans for independent directors of public companies, and for financial advisors who are registered reps with independent broker/dealers,” says Bruce Gendein, president of The Senex Group in Woodland Hills, California.

Once the form of business is established, next comes the question regarding what type of retirement plan works best. Actually, you’d think that would be the next question. It isn’t. When you’re running your own business, there are a lot of other “next questions” before we get to the one about setting up a retirement plan. “Unfortunately,” says Gendein, “for many very small businesses, discretionary income is scarce, and even when it is available, it’s often reinvested into the business. Between growing their business and covering all their living expenses, funding a real retirement plan often falls to the bottom of the list.”

At what point should gig workers begin considering what retirement plan to use? “It depends on how successful they are,” says Dinan. “Once they get to a certain level of income then they are actually in a position to start saving. Otherwise they are typically living from one gig to the next. It’s also advisable to have a higher balance in the emergency fund so they can weather the ups and downs and uncertainty of owning or being the business.”

Ultimately, and the sooner the better, those living the life of a freelancer will need to begin saving for retirement. When that time comes, a decision will have to be made. Which retirement savings vehicle should they choose? A traditional IRA? An SEP-IRA? A Solo 401k? and should they save it in a Roth or tax an immediate tax deduction?

The traditional IRA is the granddaddy of all gig retirement plans. “It works well for the young sole proprietor getting started,” says Gendein. “Their income is often consistent with the use of the traditional, or perhaps Roth, IRA.”

The IRA also has the lowest maximum contribution. Whether you pick this vehicle “depends on their income level,” says Ilene Davis a financial planner from Cocoa, Florida and author of Wealthy by Choice: Choosing your way to a wealthier future. “If they only plan to save $5500 (or $6500 if over 50), the IRA is best.”

It’s the easiest to set up and the easiest to maintain. Matthews says, “It may be better to use a traditional IRA when the amount of money you can set aside is relatively small and below the deductible limit of $5,500 and you don’t want the cost or complexity of setting up a retirement plan for the business.”

Under what circumstances does ease of setting up the IRA become most relevant? “If they haven’t relied on a professional for advice, then it’s more common to see self-employed individuals use a Roth IRA even if it doesn’t necessarily make sense for them,” says Dinan. “It just tends to be the most popular IRA. Traditional IRAs are really easy to set up and the money is fully deductible for self-employed individuals that don’t have access to a 401k. If they make 200K a year but can only save $5k, then it doesn’t make sense to open up a SEP.”

The SEP-IRA represents a hybrid between a traditional IRA and a traditional 401k. It permits you to save more and it permits the company to make contributions to all employees. While this means you can use it in LLCs and Corporations, sole proprietors may also find it more attractive than traditional IRAs. “Where the sole proprietor’s earned income is sufficient, the SEP-IRA will allow them to save significantly more than an IRA allows,” says Gendein.

Rather than the straight dollar contribution of an IRA, the SEP-IRA determines the contribution based on a percentage of your taxable wages. Davis says the SEP-IRA becomes the preferred retirement saving vehicle “If they have very high income that allows them to do the maximum contribution with 25% of income.”

It’s not just increased retirement savings that makes the SEP-IRA attractive. It’s also increased tax savings. “A savvy sole practitioner will usually opt for the low-friction SEP IRA as it enables an individual to contribute so much more on an annual basis than the traditional IRA,” says Vollmer. “In addition, larger contributions lead to a larger tax deduction.”

Here we begin to see solid metrics used to determine when the SEP-IRA is the more favorable choice. Dinan says, “Upon meeting new clients it depends on the advice that they have been given. If they have an income above $150,000 and they’ve had a good CPA helping with their taxes, then typically they will have a SEP IRA. If they have a healthy savings rate, they can defer up to 25% of your income into a SEP up to $55K. This is the best way to save on taxes and one of the fastest ways to increase your liquid net worth.”

There’s another vehicle that’s perfect for people with second income when they don’t need that second income to support their current expenses. It’s the Solo 401k plan. “We often see it in a moonlighting situation,” says Gendein. “The extra income from the sole proprietor activities is not needed for life style and the 401k deferrals allows them to save a large part of the business earnings.”

What if an independent contractor wants to save more than the maximum deduction of a traditional IRA but finds the 25% SEP-IRA cap too limiting? When people “can afford to save a lot but their income is not high enough to meet the maximum with 25%, use Solo 401k,” says Davis.

Dinan says, “People prefer the Solo 401k when they want to defer more money but don’t have a high enough income under the SEP. The Solo 401k allows you to defer up to 100% of your income (up to $18,500). The Solo 401k also provides a loan provision that isn’t available in a SEP. I’ve had sole proprietors open up a 401k and transfer their old 401ks so they could borrow against it. You can take a loan of 50% of the balance up to $50k.”

The Solo 401k also allows for a Roth option whereas the SEP-IRA does not. There are a couple of major difference with Solo 401k plans. First, they’re only available to businesses where the owner is the sole employee. This makes them perfect for the gig worker. On the downside, there may be more paperwork once the assets in the Solo 401k reaches a certain threshold. “Solo 401k plans are effective yet cost a bit more due to the annual plan administration,” says Vollmer.

If you are an active member of the gig economy, you don’t need to wait for Congress to act to start saving for retirement. You can begin saving right now. And, depending on your specific situation, you may just be able to save faster than you think.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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