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How gig economy workers can save for retirement

How to make the most of your investments

Today's gig economy is creating both opportunity and problems for millions of Americans. Gig workers include those who devote at least some of their time to providing ride-hailing services, short-term rentals of their homes or delivery services.

One powerful example is Uber. The ride hailing service, which launched its initial public offering earlier this year, said over 1.5 million active Uber drivers received more than $3 billion in payments in 2017. Active Uber drivers earn an average monthly income of about $364. Uber and other gig economy players such as Airbnb, Lyft and Doordash employ workers as freelancers or independent contractors.  

They typically receive income that's reported on Form 1099 for self-employed workers. And that usually means (unless they have another job as an employee at a company) they have personal responsibility for a lot of things, including saving for retirement.

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The best retirement savings strategy for gig workers includes setting up a retirement plan that has significant tax benefits for the self-employed. Among those benefits: Contributions are deductible from your income, and the money saved in a retirement plan account grows tax-free. Also, if you're the owner of a small business and you have employees, a retirement plan can help attract and retain them.

The self-employed can establish several types of retirement plans, but figuring out which is the best option for you can be confusing. Here are the four most common plans for the self-employed and guidance aimed at helping you decide which one is most suitable for you.

Payroll deduction IRAs

If you don't want to set up a formal retirement plan, you can open an IRA. Any employees you have can open and contribute to their own IRAs through payroll deduction. As the employer, you can decide to make the IRA contributions for some of your employees and do so by increasing their pay by the amount you want to give them. This provides a simple and low-cost way to help employees to save.

It also allows employees to decide which type of IRA is best for them: a traditional IRA or a Roth IRA. The annual IRA contribution limits for this type of plan is $6,000 ($7,000 for employees age 50 or older). You can set up an IRA as late as the due date (plus extensions) of your income tax return for a specific year. 

Simplified employee pension (SEP)

A SEP IRA potentially lets you make a larger contribution than what's allowed for a regular IRA. For 2019, you can contribute the lesser of 25% of pay or $56,000 ($62,000 if over age 50). So if your self-employed earnings are over $24,000 and you want to save more than $6,000 for retirement, a SEP IRA may be a better option than a regular IRA.

A SEP IRA is also a good option for a worker who has two jobs, one as an employee and another as a freelance side gig.

Here's an example: Say a person has income from her work as an employee and income from working as a freelancer in the same year. In 2019, she can defer up to $19,000 ($24,000 including catch-up contributions) of her salary from employment (W-2 income) into her employer's 401(k). If the employer also makes a contribution, the total SEP IRA contribution is limited to $56,000 ($62,000 if over age 50).

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Since SEP IRA contributions are considered to come from her self-employed income reported on Form 1099, none of those contributions counts toward the $19,000 401(k) salary deferral limit, so she can contribute up to $56,000, or 25% of self-employment earnings, whichever is less, into her SEP IRA.

The downside of a SEP IRA is that if you have employees, you must contribute a uniform percentage of pay into a SEP IRA for each employee. Employees aren't permitted to make their own contributions to a SEP.

Setting up a SEP entails no additional costs beyond contributions, and as the employer you can decide whether you make any contributions in any given year. A SEP for this year can be set up next year if you do it before you file your tax return.

SIMPLE IRA plan

This plan allows employees to contribute a percentage of their pay to an IRA and requires an employer to either match employee contributions dollar-for-dollar up to 3% of compensation or make a fixed contribution of 2% for all eligible employees, even if they choose not to contribute. A SIMPLE IRA plan is allowed for employers with 100 or fewer employees.

Other than the cost of making contributions, these plans also typically have no other costs to set up and operate. Like the SEP, a SIMPLE IRA can be established the following year while tax deductions for contributions can apply this year. 

Self-employed 401(k) profit-sharing plan

This is my favorite type of retirement plan because it allows the self-employed to make generous contributions both as an employer and as an employee. With this type of plan, you can make two types of contributions. One is a percentage of net profit (this is the employer's profit-sharing component). The other is a fixed-dollar amount up to the employee 401(k) contribution limits ($19,000 or $25,000 for those over age 50 in 2019).

For an individual who declares about $75,000 net profit from self-employment, the total contributable amount for this plan is about $32,940. If you're 50 or older, you can contribute about $38,940.

An self-employed 401(k) plan works best for a sole proprietor with no employees. That's because if you have any employees age 21 or older and who work at least 1,000 hours a year, you'll have to also open accounts and make similar contributions for them. Finally, you'll need to establish a self-employed 401(k) plan before year-end to make a tax-deductible contribution for this year.

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