I'm in my late 30s. For the last several years I worked in-house as a full-time employee, but last year decided to go solo, mostly doing freelance work but also filling in as a rideshare driver. I love the independence and flexibility but I'm worried about staying afloat financially. What steps should I take to support myself long term?
The timing for your question couldn't be better. A record number of people are rethinking their careers and the growing gig economy is a reflection of that. According to recent statistics, there are currently more than 59 million gig workers in the U.S., and more than 90 percent of Americans say they'd consider freelance work or independent contracting. Understandably, the main reasons are freedom, flexibility and control. But while there's a lot to be said for independence, like most things, when there's more freedom there's also more responsibility.
As an employee, you often have the security of employer-sponsored benefits like health insurance and retirement plans. Consider that benefits average around a third of a typical employee's compensation. When you're your own boss, it's all up to you. Not only do you have to budget carefully to cover everyday expenses—and ideally live below your means—you have to shore up your savings as you think long term.
Here are some steps I suggest you take right away to increase your financial security.
Set up an emergency fund
This applies to everyone—independent contractor or not. What would you do if you have an accident or illness or go for an extended period without a job? The general answer is to set aside cash to cover a minimum of three to six months of essential living expenses in a designated account that's easy to access. As a gig worker, I'd aim for six months or more. Earmark this money specifically for an emergency—and promise yourself you won't touch it until absolutely necessary.
Make sure you have the right insurance
Health insurance is number one. It may seem like a big expense, especially if you've had coverage through an employer in the past, but consider that a single hospital stay could wipe you out. You can enroll in coverage through healthcare.gov if you’re a freelancer, consultant, independent contractor or other self-employed worker with no employees. If your business has even one employee (other than yourself, a spouse, family member or owner), check out SHOP Marketplace for small businesses. At the very least, get a high-deductible policy for yourself that would cover a catastrophic health event.
Next, look into liability insurance. Regardless of how conscientious you are, things can go wrong. Make sure you have protection that covers you personally and professionally. For example, ride-sharing may not be covered by your personal auto policy.
And finally, research disability insurance. An emergency fund will cover you if you can't work for a short time, but what happens if you're unable to work for an extended period? Social Security offers some coverage, but it's limited and the rules to qualify are quite strict. A private disability policy is worth looking into. It may seem expensive, but the right kind of insurance can help save you money.
Consider a health savings account (HSA)
While we're talking about health insurance, if you have a high-deductible health insurance policy, look into an HSA. Current minimum deductibles are $1,400 for self-only coverage, $2,800 for a family.
With an HSA, you can make tax-deductible contributions up to an annual maximum. Current limits are $3,600 for a single and $7,200 for a family ($3,650 and $7,300 in 2022). You can then use that money to pay for qualified medical expenses, tax-free at any time. Any money you don't use stays invested in the account and grows tax-deferred. You can withdraw funds for any reason penalty-free after age 65, but you'll pay ordinary income taxes on that type of withdrawal, just like with an IRA. Which brings me to the next important point.
Open a retirement account
When it comes to long-term financial stability, retirement should be at the top of your list. Make it automatic. This is part of paying yourself first. As an independent contractor, you have a few choices for retirement accounts:
- Traditional IRA—Contributions may be tax-deductible and earnings grow tax-deferred. You can withdraw funds penalty-free after age 59½, but you'll pay ordinary income taxes on withdrawals. The current annual contribution limit is $6,000 ($7,000 if age 50 or older).
- Roth IRA—Consider a Roth if your income in 2021 is under $140,000 for single filers or under $208,000 for married filing jointly ($144,000 and $214,000 respectively in 2022). You don't get the upfront tax deduction, but earnings grow tax-free and withdrawals are tax-free after age 59½ if the Roth has been established for at least five years. That can make sense if you expect to be in a higher tax bracket come retirement. Contribution limits are the same as a traditional IRA.
- SEP IRA—A SEP is easy to set up and allows for higher annual contribution limits—up to the lesser of 25 percent of compensation or $58,000 in 2021 ($61,000 in 2022).
- Individual 401(k)—This involves a bit more set-up but has potentially higher contribution limits than a SEP and the option of making Roth contributions.
SEP IRAs and 401(k)s are good options if you have employees. I can't get into the details here, but an advisor at your financial institution could help you explore what makes the most sense for your situation. You can also find information at irs.gov. At the very least, open an IRA and contribute the annual maximum. In your 30s, it's smart to aim to put 15-20 percent of your annual salary toward retirement. That percentage goes up dramatically the longer you wait.
Keep up on estimated taxes
As an independent contractor you're responsible for all self-employment taxes for Social Security and Medicare. The current self-employment tax rate is 15.3 percent. You pay this by filing quarterly estimated taxes. Fail to file and you'll pay a penalty. (Hint: Put the dates on your calendar!) To keep your tax bite lower, itemize your business expenses and keep good records.
Be your own CFO
You may now be your own boss but you also need to be your own CFO. That means carefully managing personal and business expenses both for the present and the long term. If you do that, you'll know you're on track for a financially secure future. That's the ultimate freedom.
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