How Gig Workers can prepare now for retirement planning… and other considerations
by Rick KollaufMr. Kollauf is Vice President and Director of Business Advisory and Estate Planning at BMO Private Bank. Connect with him: [email protected]
The number of American “gig workers” has grown tremendously in just over a decade – from one percent of the workforce in 2005 to nearly 16 percent in 2015 to 34 percent today. While both workers and companies enjoy the flexibility gig work enables, it can have a serious impact on workers’ retirement savings. Gig work offers scant access to retirement savings plans at the company level, and the gig worker is often not focused on planning their business model to incorporate saving for retirement.
To learn more about this rapidly growing sector of the economy – why they’ve taken the gig route and the financial challenges they face – BMO Wealth Management recently commissioned a survey of more than 1,000 self-employed Americans. Our subsequent report delivered some surprising findings that have helped us inform our guidance to clients about how best to maximize retirement income while enjoying the lifestyle benefits of gig work.
Respondents of the survey highlighted the following main reasons for working in the gig economy: making extra money, being able to have autonomy and control and balancing career and family needs. Despite the flexibility that gig workers enjoy, there are challenges present when working the gig economy, which include: fluctuating income, lack of employment insurance or health and medical benefits, and the ineligibility for employer retirement plans. Moreover, the survey findings found that many gig workers of retirement age work in order to supplement their income, while younger workers aren’t necessarily thinking about what they can start doing now in anticipation for retirement. Part of planning to enter the economy as a gig-worker involves developing a business plan. Let’s get real, freelancing and independent contracting are not new work statuses. After all, that’s what a gig-worker is – a freelancing independent contractor.
Entering As Entrepreneurs
Being an entrepreneur presents new needs for the gig worker and many will need to effectuate best practices to maintain business and personal profitability. That means, as part of their business plan to develop, retain, and grow their viable income streams to support their business expenses and capital needs (including planning for the inevitable ups and downs of when they have adequate levels of income streams); they will also need to incorporate their personal income and expense needs (i.e., cash flow). Why, because their source of personal cash flow will now come from their business. This also means that their retirement needs will have to be taken into consideration from a long-term planning perspective. Gig-workers don’t have an employer looking over their shoulder parenting them to invest in a 401(k) or graciously providing pension benefits.
Many gig-workers are fully competent to understand their skill-set and what the economy demand is for them as well as how to cover the business expenses associated with running their own shop. On the other hand, most are also not equipped to understand the administration, costs, and funding necessary to incorporate an adequate retirement plan into their business model. The best solution to this is seeking counsel with a wealth planner. The best entrepreneurs know what they don’t know and how to build an advisor team to help them in those instances. Seeking financial advice from a professional is one tip we recommend always for financial success in a gig economy. Others included: developing a business plan that incorporates a budget; maintain organization and discipline; protecting yourself with an emergency fund, healthcare coverage and other insurance; pay off debt; and save for other goals such as education and retirement.
What are some planning considerations that factor into adequately saving for retirement as a gig-worker?
Take care of the short term: business plans and financial plans have different focuses but in the gig world business and personal financial success is interrelated. A business plan will help your business succeed by providing the guidelines on how you will make the money that will be needed to cover all your expenses, including the lifestyle expenses of your personal financial plan. From a short-term perspective, you should not only be able to cover your spending, but be able to build an emergency fund for the unexpected and inevitable ups and downs in your business and personal life, and cover necessary insurance for the business’s liability and personal medical needs.
Now the hard part – going above and beyond the short-term. This means covering funding for things like children’s education, debt payments, and very importantly– retirement.
From the beginning, it is important to understand how you will operate your business (i.e., what your entity selection will be: sole proprietorship, LLC, S Corporation, or C Corporation). The type of entity you select plays a big role in the taxation of your earnings (one of your biggest expenses) and the availability of what types of benefits (including retirement) you are able to accommodate.
Social security – it may or may not be around when you are retiring, so some will plan their retirement savings accounting for social security as an income stream in retirement so they essentially save less while others plan for no social security and save more. One way to supplement the fact that if you plan to receive social security and when you retire it is not there or is less than you anticipated is to either work longer (continue your full time gig to save more for less of a period of retirement) or plan to work a side gig in retirement to augment the lack of savings you have acquired.
One difficulty gig-workers find is that they are typically not classified as employees of the company they are working for and as such don’t have access to the employment benefits, including retirement savings plans, that the company provides is full-time employees.
What types of tax-advantaged strategies are available once the plan is made to start and grow retirement savings for the gig-worker? First you have to have earned income; meaning your business can’t be losing money and the money it makes must qualify you for the retirement savings vehicle rules in the strategy(ies) you select. Consider the following options:
- IRA – Single filers can save as much as $5,500 per year (add another $1,000 when you reach age 50). Savings reduces income and growth is tax deferred. Presumably at the time withdrawals start in retirement, you are in a lower tax bracket than you were in when you made the deductible contribution.
- Roth IRA – limits similar to a regular IRA but there is no income reduction; however, the withdrawals (including earnings) are generally tax free. You are precluded from contributing to a Roth if your single filer income exceeds $135,000 ($199,000 if married filing jointly).
- SEP IRA – the employer contributes to an employee’s account up to 25% of compensation (up to $55,000). So, if you are self-employed this equals 20% of your net profit as you need to subtract SEP contributions and half of self-employment taxes. As you can see, the design of this plan allows for much greater retirement savings by the small business owner. If you have other employees, you need to include them in the plan.
- SIMPLE IRA – allows the employee to defer a component of their salary (up to $12,500 or $15,500 if age 50 or older) along with the employer to match up to 3% of compensation. These are higher limits than a regular/Roth IRAs like a SEP, but also like a SEP they require you to include other employees to a degree.
- Solo 401(k) – Single workers can save as much as $18,500 per year ($24,500 if age 50 or older) and employers can contribute similar to the SEP IRA rules above. So, even if you are not working for a regular employer, the 401(k) is still available.
- 401(k) – more appropriate if you plan to have a greater number of employees working for you.
- Pension plan – The least often used vehicle for small business owners but very important to consider the cash balance pension plan when considering a retirement plan overall. This is a defined benefit plan (unlike the defined contribution plan type a 401(k) is) and in which the employer contributes a set percentage of your compensation plus an earnings component. If you have neglected your retirement savings until later in life and are still working your gig, this may be the plan for you as it allows a rapidly accelerated savings because it targets a defined benefit that needs fund the plan as of your anticipated retirement date.
Planning for a retirement savings might not come to mind immediately for the gig workers, however building a solid plan for retirement and understanding what it involves will be useful for the long run. Consider the following as you start to account for retirement: your expected mortality, lifestyle expenses during retirement, accounting for retirement earnings and inflation, and calculating how much would be needed to be saved each year prior to retirement (factoring in pre-retirement earnings and inflation).
These calculations are not for the faint of heart and as mentioned above you should consult with a wealth planning advisor. You should also know that the employee-deferral limitations mentioned above apply across all plans. If you are a side gig-worker and are in a 401(k) at your regular job, your gig 401(k) (or other plan) plan can only be funded with the amount you are not able to maximize at your regular job. Also know that the employer portion of the retirement savings contributions are plan specific so that even if your regular employer maxed out their contribution, your gig 401(k) has a full separate limitation.
Once you have a solid plan, be disciplined in your approach. Understand that peaks and valleys may occur in your income but discipline would either have you continue the planned savings amount or adjust to save more in the good times and less in the down times. Finally, don’t forget that the retirement savings account needs to be invested in something. Investing in a CD not even earning the annual rate of inflation is like investing in worse than nothing; so again, consult a professional advisor to help.◊