The gig economy is here to stay. More than one-third of the American workforce is already part of this on-demand economy, and researchers predict these figures are likely to go up to 50% by 2027. Not only does the gig economy offer flexible work hours, but participants are at the liberty of choosing their clients and projects, along with the additional benefit of working remotely.
However, freelancers and other gig economy workers miss the benefits offered by traditional employment opportunities. They’re responsible for their retirement savings, healthcare expenses and other forms of long-term savings.
How Freelancers Can Create A Sizeable Nest Egg
The ideal strategy for gig economy workers is to establish a retirement account and start contributing. There are multiple retirement plans available for self-employed professionals and part-time freelancers, including individual retirement accounts, self-employed 401(k) plans (also known as solo 401[k] plans) and simplified employee pension IRAs, among others.
• IRAs: Much like any employer-sponsored retirement account, freelancers can set up individual retirement accounts and start contributing. They can contribute up to $6,000 annually, along with a catch-up contribution of $1,000 for professionals over 50. The account holder can choose between a traditional IRA or Roth IRA.
• SEP IRA: An SEP allows the plan participant to contribute up to a quarter of their income, up to $56,000.
• Self-employed 401(k) or solo 401(k): This offers the most flexibility when it comes to retirement contributions and allows the plan participant to contribute up to $62,000 every year. Since a custodian is not required for this plan, this equates to lower maintenance costs and investment options beyond the stock market. These can include physical real estate, multifamily syndication or commercial property, private lending, tax liens and more.
The Pros And Cons Of Self-Directed Retirement Accounts
Since self-employed professionals enjoy freedom in their schedule and choice of work, it makes sense that they might want to extend that same privilege to their retirement planning. Luckily, some retirement accounts offer investment discretion and self-direction features, such as self-directed 401(k) plans and self-directed IRAs.
Self-directed retirement accounts allow plan participants to invest in alternative investments. As a self-employed professional, one could leverage his or her industry experience to make long-term, limited-period investments.
Self-directed solo 401(k) retirement plans allow participants to choose different investments for their retirement portfolio. Depending on the plan document provider, plan holders can choose among real estate, private equity, precious metals, and regular stock or bond investments.
In the case of a self-directed IRA, the plan holder needs a custodian to act as a trustee of the account. A custodian could be a bank, brokerage firm, an insured credit union or a legal entity approved by the IRS. It is essential to understand that custodians are not authorized to extend investment advice to the plan participants.
A self-directed solo 401(k) is structured with a 401(k) trust used as a vehicle to hold the plan assets. The account holder is designated as the trustee and as such has total control over how the plan assets are invested. Additionally, solo 401(k) plans allow post-tax Roth contributions to a separate designated Roth account under the same plan, allowing investments to grow tax-free as well as tax-free qualified distributions.
However, freelancers must consider the risk that comes with the self-direction of their retirement accounts. They are solely responsible for making their investment decisions, which means they could lose their retirement savings if their investments don’t work out. Additionally, they need to be aware of the regulations surrounding their investments, such as prohibited transactions and the rules associated with withdrawals and participant loans.
Freedom Versus Risk
The gig economy is set to expand in the coming years, so it makes sense for freelancers to embrace the financial responsibilities that come with the freedom the on-demand economy offers. Like with any investment, there is risk involved with self-directed accounts. However it can be mitigated when investment is collateralized. An example is a trust deed secured by real property or shares of syndication where you can own a piece of a large commercial property professionally managed. Some of these investments may require accredited investor status, but if you start today, you might later be in the position to enjoy the benefits of being passive investor.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.