For better or worse, the gig economy is here to stay. It offers flexible hours, choice in their clients and projects, and the benefits of working remotely. However, freelancers and other gig workers miss out on the benefits offered by more traditional employment, says Forbes in the recent article “What Gig Workers Should Know About Self-Directed Retirement Accounts.” One aspect that can have significant implications is that they are completely responsible for their own retirement savings, health care expenses and any other forms of long-term savings.
How can a freelancer build a nest egg? It can sound quite simple: establish a retirement account early on and start contributing, no matter what the amount. There is no lack of retirement plans available today for self-employed professionals and part-time workers, including traditional IRAs, self-employed 401(k) plans, and simplified employee pension IRAs, among others. The challenge comes from having the income and the discipline to do this.
IRAs: Freelancers may set up individual retirement accounts directly with a custodial institution, contributing up to $6,000 annually. For those who are 50 and over, there’s an additional catch-up contribution of $1,000 permitted. A freelancer can decide to go with a traditional IRA or a Roth IRA.
SEP IRAs: Simplified Employee Pension IRAs allow freelancers to contribute up to 25% of their income, or $56,000, whichever is less. This may be a good option if you are a one-man show and intend to keep it that way. If you are an employer, you have to contribute to the SEP-IRA of every eligible employee whenever you contribute to your own SEP-IRA.
Self-employed 401(k) or solo 401(k): This plan offers the most flexibility for retirement contributions. The person can contribute up to $62,000 each year. These plans also have a lower maintenance cost and investment options that go beyond the stock market, since there is no requirement that the plan has a custodian. The accounts can include real estate property, commercial property, private lending, tax liens or multifamily syndication.
The Good and the Bad of Self-Directed Retirement Plans
Self-directed retirement accounts allow participants to invest in alternative investments. That can be a good thing; for example, a self-employed professional can leverage their industry experience to make long-term limited period investments, and not be limited to the offerings of a traditional custodian. For a self-directed IRA, the plan holder does need a custodian to act as a trustee of the account. That could be a bank, brokerage firm, insured credit union or a legal entity approved by the IRS. The custodian is not authorized to provide investment advice to plan participants.
The self-directed solo 401(k) is structured with a 401(k) trust, used as a vehicle to hold the assets. The account holder is the trustee and has total control over how the assets are used. Solo 401(k) plans allow post-tax Roth contributions to be made to a separate designated Roth account under the same plan. That lets investments grow tax-free, as well as tax-free qualified distributions.
However, with all this freedom comes risk. If investments don’t work out, there’s no safety net. There are also many regulations around these self-directed accounts. Some transactions are prohibited and there are rules regarding withdrawals and participant loans. If you are a freelancer, you should consult with an attorney or financial advisor to figure out the best way you can contribute to your own future.
Reference: Forbes (December 5, 2019) “What Gig Workers Should Know About Self-Directed Retirement Accounts”