By Joanne Szupka, Beth Garner, and Bob Criscuolo, BDO, USA, LLP
The gig economy is growing, and there are many reasons why workers are looking to build careers as independent contractors as opposed to traditional W-2 employees. Some of the reasons the contractor lifestyle is attractive for American workers include flexible hours, the ability to work remotely, improved work-life balance and more control over their careers. Despite these positives, contractors are missing a critical component of their financial future: a company-sponsored retirement plan.
Freelance, independent contractor and other non-traditional employment relationships are all considered 1099 workers. By law, companies aren’t allowed to offer 1099 workers the opportunity to participate in the company’s retirement plan.
But that doesn’t mean employers should disregard their contractors’ retirement needs. Financial wellness is important to all workers’ productivity, regardless of whether they are paid via W-2 or 1099. From a retention standpoint, if contractors feel that they aren’t on track for their retirement goals, they may look for full-time W-2 employment at another company.
The gig economy is an increasingly important part of the labor market. The State of Independence in America report by MBO Partners found that nearly 42 million Americans worked on a contract basis in 2018, a 2.2 percent increase from the previous year. More than 3 million of those contract workers are highly-skilled workers earning more than $100,000 annually, according to MBO.
Even though contractors can’t participate in the employer-sponsored retirement plan, there are still things companies can do to help 1099 workers prepare for retirement and understand the retirement savings options available today. In some cases, contractors could be saving more annually in tax-deferred retirement accounts than their W-2 counterparts. Informing contractors about these opportunities could be a way to help them feel more connected to your organization and less financially stressed about their future.
How Much to Save?
Providing information to help contractors determine how much they need to save for retirement can be an important first step in a) motivating them to save and b) helping them determine which retirement plan is the best fit. There are myriad retirement calculators available through commercial providers, but the Social Security Administration and the Department of Labor (DOL) also offer these tools. In addition, the Consumer Financial Protection Bureau has a detailed education page designed to help people plan for retirement. The DOL also offers a Lifetime Income Calculator to help people understand what a monthly income stream might look like.
What Retirement Savings Vehicles Are Available?
There are several types of tax-advantaged qualified retirement accounts available to contractors and other self-employed workers. One of the most difficult decisions contractors face when setting up their personal retirement accounts is determining which one best aligns with their financial situation. This requires understanding the eligibility requirements, contribution limits and other rules related to these accounts.
Traditional or Roth Individual Retirement Account (IRA). An IRA may be the best option for lower-income workers who are limited in the amount they can afford to save for retirement. In 2019, IRA participants can save up to $6,000; those age 50 and older can add a $1,000 catch-up contribution. Individuals can take a tax deduction for traditional IRA contributions; Roth users contribute post-tax, but the growth of the assets is tax-free.
It’s important to note that workers must be below the income limit ($137,000 for single tax filers and $203,000 for married joint filers, with phase-outs starting at lower income levels for both types of filers) to contribute to a Roth IRA.
Simplified Employee Pension (SEP) IRA.
This plan can be an attractive option for solo contract workers or those who have only a few employees in their company. SEP users can contribute the lesser of $56,000 in 2019 or up to 25 percent of net compensation. Under this plan, all contributions to employee and employer SEP accounts must be equal. SEP IRAs often have very low administrative costs and are easy to set up and operate.
This plan, also known as a one-participant 401(k) plan, can be an attractive option for self-employed workers who don’t have any employees. For 2019, Solo 401(k) contribution limits are $56,000 or 100 percent of income, whichever is less. In addition, spouses can participate and contribute the standard 401(k) contribution limit, which is $19,000 in 2019. Users and spouses can make $6,000 catch-up contribution each, if they are over age 50.
These plans may require more administrative work and costs than a SEP IRA; once the plan balance exceeds $250,000, the owner may be required to file an annual 5500 report.
Insight: Deliver the Facts
Not everyone has access to a company-sponsored retirement plan—but all workers should be saving for retirement. In addition to contract workers, many part-time employees don’t work enough hours annually to participate in the company’s retirement plan.
Employers have an opportunity to help these groups prepare for retirement by providing information about the retirement plan options that are available to them. Helping contractors and part-time employees enhance their financial wellness and security can be a powerful retention tool—something that is especially important in an extremely tight labor market.