Retirement Planning for the 'Gig' Economy

Changes have been coming fast and furiously for workers in the gig economy.
Before the pandemic, the number of gig workers--a broad coalition that includes delivery and ride-share drivers as well as contract-based knowledge workers--was growing quickly. The number of such workers jumped by 15% in the decade through 2019, and 16% of workers at U.S. businesses were independent contractors in 2019. 

Enter the pandemic. While the broader trend toward companies hiring fewer permanent employees still appears to be intact, the coronavirus crisis has changed the landscape. Ride-share driving jobs through once-booming services like Uber and Lyft disappeared almost overnight, while the number of gig jobs in the food-, grocery-, and package-delivery areas increased. The types of workers seeking these jobs have changed, too, as those who were laid-off and furloughed sought to replace their incomes, while some older workers or those with pre-existing health conditions that make them vulnerable to COVID-19 complications have stepped away.

Self-employed individuals have a completely different set of opportunities and challenges, from both a lifestyle and financial perspective, than those who work full-time for a single employer.

One of the traditional selling points for contractors is the ability to better balance work and family obligations. For some parents during the pandemic, for example, their daytime roles as at-home learning instructors have all but necessitated gig work during nonschool hours. Contract work, especially in certain specialized fields such as technology, can also be lucrative financially.

At the same time, not having a steady paycheck--not to mention missing out on crucial employee benefits like health insurance--can be a source of financial stress. While the CARES Act extended unemployment benefits to some self-employed workers and independent contractors, the threat of periodic income disruptions may also make workers with nontraditional employment arrangements less likely or less able to save for long-term goals. If they know they could have a months-long disruption in their paychecks, they might be reticent to park extra funds in a retirement account that carries strictures on premature withdrawals. In fact, just 13% of self-employed individuals surveyed by Pew Research reported saving for their retirements in their current jobs.

Moreover, self-employed workers won't receive employer-provided matching contributions, nor will they be able to take advantage of creature comforts that participants in company-provided 401(k) plans enjoy, such as automatic enrollment and automatic rebalancing.

But self-employed individuals can and should take steps to ensure their retirement security, just as people in conventional work arrangements should. Here are some tips to help them do so.

First Stop: Assess Insurance Coverage
Building retirement savings is important for contractors and other people in nontraditional work arrangements. But before they focus on retirement savings, such workers should first ensure that they've adequately protected themselves against shorter-term financial hardships, which can derail their plans to achieve long-term financial goals. If a self-employed person is forced to turn to unattractive forms of financing such as credit cards to defray near-term income needs, the cost of that financing is likely to swamp the long-term returns on any money earmarked for retirement.

Raiding retirement assets like IRAs prematurely is also a suboptimal choice, as doing so usually carries taxes and a penalty. The CARES Act included a provision that allows people to withdraw from their IRAs and 401(k)s without paying the usual 10% penalty, and to pay that money back over three years. But that provision is limited to those who have been adversely affected by COVID-19, either physically or economically, and ends in 2020.

Here, lining up adequate insurance coverage is an essential first stop, especially healthcare and disability coverage. Workers who are participating in a qualifying high-deductible healthcare plan may also contribute to a health-savings account, which allows them to build up funds to defray out-of-pocket healthcare costs. Such funds receive extremely attractive tax breaks, making them a no-brainer for workers enrolled in qualifying high-deductible healthcare plans. (If they're going to be on the hook for any out-of-pocket healthcare expenses at all, they might as well run the money through an HSA and get the tax breaks.) HSAs can feature layers of fees and may have unattractive investment options. But self-employed folks also have a leg up on workers with employer-provided HSAs, in that the former can shop around for the best low-fee HSA options. Morningstar has two favorite HSAs for people who are spending from their accounts: Fidelity and Lively.

Next Stop: Bulk Up Emergency/Short-Term Reserves
In addition to conducting an insurance fire drill, contract workers should also assess the adequacy of their liquid reserves before earmarking assets for retirement. The main reason to amass a so-called emergency fund is to provide cash flow in case of job loss. And lumpy income streams, as well as periodic income disruptions, are all but facts of life for contractors and other self-employed individuals. Moreover, disability coverage may be cost-prohibitive for self-employed people. All of these factors argue for self-employed workers maintaining emergency funds that are larger than the standard three to six months' worth of living expenses often prescribed by financial planners; I think closer to a year's worth of living expenses makes sense for self-employed individuals. And if taxes are not being withheld from a contractor's paycheck, that cash fund can also serve as a receptacle for monies earmarked for taxes.

Next Stop: Fund a Basic IRA
Moving on to the retirement accounts themselves, contractors and other self-employed individuals have what may seem like an overwhelming array of accounts to choose from.

But a good first stop for any self-employed worker or contractor is to simply fund an IRA to the maximum--in 2020 and 2021, that's $6,000 for investors under age 50 and $7,000 for those over 50. Such accounts are very easy to set up, and the money can be invested in a huge array of options. Nor will IRA contributions affect a self-employed person's ability to contribute to a dedicated retirement-savings vehicle for self-employed people, such as a Solo 401(k).

Traditional IRAs offer a tax deduction for investors who fall below the income thresholds, but Roth IRAs offer quite attractive features, too: no taxes on qualified withdrawals and no required minimum distributions in retirement. Roth IRAs carry income limits, too, but they're higher than the income limits for traditional deductible IRAs. A Roth IRA can be especially appealing for self-employed workers in that they can withdraw their contributions (not investment earnings) at any time and for any reason without paying taxes or a penalty. Thus, the wrapper can be a good one for multitasking--both saving short-term reserves for emergency expenses as well as investing for retirement.

Next Stop: Find a Way to Save More for Retirement
Self-employed workers contributing to an IRA shouldn't stop there, because the contribution limits are quite low relative to other retirement-funding vehicles. A person assiduously investing $6,000 a year in an IRA for 40 years who enjoyed 6% growth on her money would have a little over $920,000 at the end of the period. That's nothing to sneeze at, but nor is it enough to fund retirement for many households, especially considering the effects inflation will have on purchasing power over that 40-year period.

For that reason, individual self-employed workers looking to amass significant sums for retirement need to take a look at additional receptacles for retirement savings. Tax and Social Security expert Mike Piper believes that the individual (or Solo) 401(k) is attractive because it offers both high contributions and a Roth option. He also notes that while administrative costs had been a knock against Solo 401(k)s in the past, they've come down significantly at some of the big providers in recent years. His site includes a Solo 401(k) Contribution Calculator to help people determine whether--and how much--they can contribute. 

Would self-employed workers with finite resources ever have reason to put the Solo 401(k) contribution ahead of IRA contributions? Piper points out that might make sense in a few situations. One would be for people who can't make a direct Roth IRA contributions because they earn too much. In that instance, contributing to a Solo Roth 401(k) will be simpler than doing a backdoor Roth IRA, which requires a few steps. "But ideally if your earnings are at that level, you're doing both," he said.

Piper also notes that assets in the Solo 401(k) may be more accessible to older workers than IRA assets; that might be another reason for self-employed people to favor investing in the Solo 401(k) rather than the IRA. That's because distributions from a 401(k) are free from the 10% penalty that normally applies to early withdrawals from a retirement plan, provided the person has separated from service with the employer in question in or after the calendar year in which they turn age 55. That provision applies to Solo 401(k)s, too; Piper notes that in this instance, "separation from service" means the person has ceased to operate the business in question. On the other hand, he points out that Roth IRA contributions are accessible at any time and for any reason, as outlined above.

For all of these accounts, self-employed individuals should emulate the "autopilot" effect that can be such a powerful source of accumulation for people in 401(k) plans. Rather than dumping the money into one of these accounts before the deadline each year, they should take advantage of the automatic investment features that can accompany many of these accounts, contributing fixed sums at regular intervals.

Next Stop: Invest With an Eye Toward Your Human Capital
At first blush, retirement savings for self-employed workers should be invested just like the savings for any other worker. Investors with longer time horizons to retirement can take more risks in search of higher growth, whereas those with shorter time horizons should balance risky, faster-growing investments with more-stable, slow-growth investments.

That's generally true. Yet as noted above, self-employed workers often have more volatile income streams than their counterparts who receive fixed, regular paychecks. While it's never ideal to withdraw retirement funds early, the odds are higher that self-employed workers will need to tap their accounts unexpectedly or prematurely. Thus, self-employed workers' investment portfolios should arguably be managed a bit more conservatively to reflect that possibility. That prospect also argues for self-employed individuals holding some of their retirement assets in discrete conservative holdings rather than obtaining that same conservative exposure via an all-in-one product like a target-date fund.