An increasing share of American workers have found themselves in nontraditional work arrangements over the past 10 years, according to Christine Benz, director of personal finance at Morningstar. In 2019, 16% of U.S. workers were independent contractors.
Related: 5 Major Trends Seen Among Independent Workers
Some employers are turning to independent contractors as a way to cut labor costs, while some workers have been forced to turn to the gig economy as a way to supplement income lost to the pandemic. Benz notes that gig workers weren’t spared by the pandemic-led increase in unemployment as ride-share jobs “disappeared almost overnight” while delivery jobs increased.
Like their traditionally employed counterparts, self-employed workers need to prepare for retirement, but they have more obstacles to saving. Workers with unstable income streams are more reluctant to lock up money in qualified accounts, Benz noted, and forget about an employer match or auto-enrollment.
With those barriers in mind, Benz recommended four factors self-employed workers need to consider to protect their retirements.
Retirement isn’t the only concern
Benz noted that people in nontraditional work arrangements need to take retirement saving into their own hands, but their first priority should be to make sure they have enough insurance to stave off short-term financial crises.
“If a self-employed person is forced to turn to unattractive forms of financing such as credit cards to defray near-term income needs, the cost of that financing is likely to swamp the long-term returns on any money earmarked for retirement,” she wrote.
While some investors may balk at paying high health care deductibles when money is tight, an HSA is a powerful tool, such that Benz notes “if they’re going to be on the hook for any out-of-pocket health care expenses at all, they might as well run the money through an HSA and get the tax breaks.”
The good news for self-employed people is that they don’t have to take the HDHP and HSA offered through an employer, she said—they can shop around to find accounts that offer the lowest fees.
Build emergency cash funds
One saver’s “emergency” cash fund is another’s income stabilizer. As Benz points out, “lumpy income streams, as well as periodic income disruptions, are all but facts of life for contractors and other self-employed individuals.”
She encourages self-employed workers to save enough to cover longer fallow periods than the three to six months generally prescribed, even as much as a year.
Max out an IRA
Contribution limits on IRAs are fairly low for 2020 and 2021, Benz writes: $6,000 for investors younger than 50 and $7,000 for older investors.
She adds that Roth IRAs have some benefits of particular interest to self-employed people. They can withdraw contributions at any time without having to pay taxes or penalties on the withdrawals.
“Thus, the wrapper can be a good one for multitasking — both saving short-term reserves for emergency expenses as well as investing for retirement,” she writes.
Don’t stop saving
Even with the IRA, Benz writes, self-employed people should keep looking for other ways to save for retirement. As noted, IRA contribution limits are low. Investors who save $6,000 a year for 40 years and earn 6% could save $920,000, according to Benz.
“That’s nothing to sneeze at, but nor is it enough to fund retirement for many households, especially considering the effects inflation will have on purchasing power over that 40-year period,” she wrote.
Solo 401ks are a good supplement to IRA savings because they have high contribution limits ($19,500 in 2020 and 2021, or $26,000 in 2020 and 2021 for savers 50 or older) and a Roth option, according to Benz.
Related:
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Beyond Fiduciary: A Moral Argument for 401ks
Innovative Retirement Solutions Are Required for Gig Workers
Danielle Andrus works as an editor for The Financial Planning Association® (FPA®). Over the past 15 years, she has worked in various capacities, including writing and editing. Andrus has worked for several notable publications and outlets and spent more than seven years as the executive managing editor at ALM Media, publisher of Investment Advisor magazine and ThinkAdvisor.com. Before that, she was online editor for Summit Professional Networks, where she oversaw newsletter development for four magazines, including Benefits Selling, Senior Market Advisor, Boomer Market Advisor, and Bank Advisor.
I never considered funding my retirement through a 401k. I need an account that will work on index funds. I’ll have to consider getting an estate lawyer to help with the strategy.