Self-Employed in the Gig Economy? Watch Out for This – Solopreneur Retirement Funds 2019

Solopreneur Retirement Funds 2019

Whether you call yourself a solopreneur, self-employed, or freelancer, you’re most likely a hard-working individual with the best boss ever – You! However, as sole-decision makers, we solopreneurs often suffer from a lack of objective feedback. This can be especially damaging when it comes to taking care of our own basic personal needs.

If you want your business to flourish, you need to take care of yourself first

Managing all aspects of a business, from marketing to operations, requires even the most disciplined among us to push beyond our limitations. It’s easy for us to ignore our own welfare. When you are your business, you have to wear many hats. But why do we so often forget to wear the most important one – our HR hat? If you want your business to flourish, you need to take of yourself first. You need to understand your options for solopreneur retirement funds. This topic is especially critical when we consider the future we are entering.

The gig economy is a different playing field

Today, 36% of American workers are gig economy workers. By 2020, that figure is expected to increase to 40%. With 53% of companies now also opting for more flexible workers, this trend will only increase. What this means is an increase in both completely independent workers and contract workers with zero benefits.

In the gig economy, there are no benefits

In the gig economy, there are no benefits, no guarantees of a minimum wage, no guarantees of a steady paycheck, no company-sponsored retirement savings plans or saving into social security. And this is a reality that solopreneurs must come to terms with and manage, on top of everything else.

If this is the future we face, how can we take care of our own welfare while scaling our business?

Related: Ten Quick Ways to Make Money While Helping the Planet

Paying yourself is more than simply reinvesting

In the gig economy, if you don’t invest in your own retirement, who will? You can bet 100% that your business will win but you still have to hedge. Risk mitigation is what keeps events from becoming ruinous. Remember that you are not your company. If your business fails, you will still need to be healthy and solvent as you seek your next adventure. Having solopreneur retirement funds to fall back on can make the difference between whether this is possible or not.

You can bet 100% that your business will win but you still have to hedge.

We know that it can be confusing to figure out the different solopreneur retirement funds options out there. With Solo 401(k), Roth Solo 401(k), SEP IRA, Roth IRA, Self-Directed IRA and Health Savings Accounts, how do you know what is right for you? 

Well Wallet cares about this topic because we are you! We are entrepreneurs and freelancers. too! So we have done the research for you. In Part 1 of our Solopreneur Retirement Fund Series, we’ll cover two retirement vehicles you should look at:  the Solo(k) and the Roth Solo(k).

The Solo 401(k)

A Solo(k), (also known as a Self Employed 401(k), Individual 401(k) or i401K,) is a plan for business owners (with no employees) and their spouses. When you have a Solo(k), you get to play two roles:  that of the employer and that of the employee.

Bonus: this means that you get to make contributions through both of those roles.

When you have a Solo(k), you get to play two roles:  that of the employer and that of the employee.

You as the Employer:  You are the employer and can contribute up to 25% of your net self-employment income, up to a maximum of $56,000, which is your business income minus half your self-employment tax. These pre-tax contributions* lower your taxable income and help cut your tax bill.

You as the Employee:  You are the employee and are allowed to contribute pre-taxed* earned income up to the annual contribution limit.  For 2019, you can contribute up to $19,000 as an employee even if $19,000 represents 100% of your self-employed earnings for the year! (If you’re over 50, you get an additional $6,000 added to your contribution limits for a total of $25,000.)

Bottom line: As both employer and employee, you can contribute up to $56,000 for the 2019 tax year ($62,000 if age 50 or older). If your gig is taking off this year, this is a fantastic solopreneur retirement fund opportunity.

*Pre-tax contributions and their earnings will be taxed as regular income when they are withdrawn in retirement. If you want to avoid being taxed when withdrawing contributions and their earnings, you might want to consider adding a Roth Solo(k).

The Roth Solo(k)

Another option is the Roth Solo 401(k). While Roth contributions are taxed, you will not be taxed on the contributions or their earnings when you withdraw them after the age of 59 ½.

Note: this assumes you have had the account open for at least 5 years.

Roth contributions are taxed before, not after

So, while Roth contributions don’t give you a tax break now, you can withdraw the money (and the gain on that money) tax-free in retirement. Depending upon whether or not you think you will be in a higher or lower tax bracket by that age, this can give you quite a break at the end of the road.

You can only contribute up to $19,000 of employee contributions annually to the Roth Solo(k). Like the Solo(k), you get an additional $6,000 added to your contribution limits for a total of $25,000 if you are over 50.

There is no employer contribution with the Roth Solo(k)

Related:  Forget Retirement – Here’s Why You Need to Start Investing Now

Top Questions to Ask When Setting up a Solo(k)

To set up a Solo 401(k), you need to complete an application to open an account with a financial institution. Solo(k)s are offered by the largest retail brokers, including Vanguard, Schwab, and Fidelity. You’ll definitely want to shop around a bit and compare plans at different institutions. Here are some important questions you’ll want to ask while shopping for your Solo 401(k):

1) What investment options should I choose?

Once you open the account, you then need to pick the investments in the account. Make sure that your plan provider offers total stock market index funds that are low cost (low expense ratio), have no sales loads and have commission-free trades into these funds.

Why you should choose passively managed index funds

  • Low Cost

If you hire someone to manage your investments for you, that person tries to beat the market by picking and choosing investments. He or she performs an in-depth analysis of many investments in an attempt to outperform the market index, like the S&P 500.

Hiring someone to actively manage your funds takes a big cut out of your return.

Hiring someone to actively manage your funds takes a big cut out of your return. There’s the expense ratio, which is a recurring fee the fund deducts from your account. There are sales loads, which you pay when your manager buys your funds. There can be commissions and a myriad of other fees that investors just aren’t aware of when they hire an advisor to pick their funds or invest in actively managed funds.

For the 15-year period of April 1, 2001 through March 31, 2016, only 29% of actively-managed U.S. large company funds were able to beat the S&P 500 Index. – The Balance

You would hope that after all of these fees are deducted, the performance of your funds would beat the market, right? Unfortunately, the opposite is often true. Actively managed funds rarely beat the market over time, and they are more costly.  But what if there was a simple and cheap way to passively own a small piece of the entire stock market instead of paying someone to try and “guess” which stocks might beat the market? Well, there is. They are called index funds.

  • Broad diversification

An index fund tries to mimic the returns of an index it follows (such as the S&P 500) by purchasing all (or almost all) of the holdings in the index. Thus, they are referred to as “passively managed” and are therefore cheaper to buy. Instead of paying someone to try and pick a winner that beats the market for you, you are actually just buying the whole market.

  • Tax efficiency

Another benefit of index funds is that they are tax efficient. Index funds have extremely low turnover while actively-managed funds often have high turnover ratios. Higher turnover = higher taxes. When funds have more buying and selling activity (aka turnover), some securities will probably sell at a higher price than they were purchased. That means you’ll be paying capital gains taxes more frequently. 

So, to recap. Index funds offer:

  • low cost
  • broad diversification
  • tax efficiency
  • set and forget simplicity (no day trading)
  • superior performance

These index funds have broad coverage and very low expense ratios

(As of April 2019)

Vanguard VTI Vanguard VTSMX Vanguard VTSAX Schwab SWTSX Fidelity FZROX

* Initial minimum investments into retirement accounts such as the Fidelity Simplified Employee Pension-IRA, Keogh, Self-Employed 401(k), and Non-Fidelity Prototype Retirement accounts are $500 or higher. 

**NEW index fund from Fidelity – with zero expense ratio. They are the first to get rid of the expense ratio for their total market index.

*** No loads or trading fees when you purchase from the fund’s platform. For example, if you choose a Fidelity Total Market index fund and trade through your account at Fidelity, you will not be charged a commission. However, if you trade that same Fidelity index fund through an account at Schwab, you will be charged a trade fee. Tip: open an account with the broker that has the funds you want.

Why We Like Vanguard (No, we aren’t paid to say this.)

We like Vanguard because their Total Stock Market Index fund has the most companies (about 3,600). That’s almost every publicly traded company in the U.S. They also have some of the lowest expense ratios (0.04%) and no trading fees. That means you can invest every single month without paying commissions. Also, Vanguard pioneered the index investing movement and operates its business at cost. Vanguard has no outside owners. If you own a Vanguard fund, you own part of Vanguard. We think this keeps the incentives in the right place. 

Bonus (this applies to any broker): you can split your contributions between total stock market funds and an investment strategy YOU believe in. (For the folks at Well Wallet, that would be sustainable investing.)

Related:  4 Ways to Make Real Money with Sustainable Investing

2) Loans:  Can you take loans from the plan?

Federal law allows workers to borrow up to 50% of their account balance, up to a maximum of $50,000. But be very careful with loans from retirement accounts. Some 401(k) plans ban contribution for six months after a loan. Also, remember that you will be paying both the loan payment and the interest on that loan with post-tax dollars. Finally, a loan from your 401(k) takes your earnings out of the market. While loans can be helpful during times of crisis, make sure you understand the rules regarding them.

3) Rollovers:  Are they allowed into and out of the plan?

You may find yourself in a position later where you are working for an employer again. In this case, you may want to roll your Solo 401(k) into your employer’s Traditional 401(k) in order to take advantage of employer matching if their plan allows it. You may also want to roll an existing 401(k) into a Solo 401(k) or roll your Solo 401(k) into an IRA or visa-versa. For these reasons, find out if your plan can be structured to accept rollovers.

4) Does the plan offer a Roth option?

As mentioned above, a Roth option accepts taxed employee contributions. This means that you can invest all or part of the $19,000 and you will not be taxed on the contributions or their earnings if you withdraw them after the age of 59 ½ (and if you’ve had the account open for 5 years.)

Note:  Employee contributions must be made by the end of the calendar year but you can make Employer contributions until the tax-filing deadline.

Tip: Be sure to open your Solo 401(k) account before December 31st, 2019 to be able to make employee contributions and lower your taxes for the tax year 2019.

Rules about Withdrawing funds from a Solo 401(k)

  • If you make withdrawals before you are 59½ they may be subject to a 10% early withdrawal penalty in addition to any applicable taxes. This is a big deal. Don’t withdraw your funds early. If you have to, take out a loan and pay the interest back to yourself before liquidating the account. 
  • You must take required minimum distributions from Solo 401(k)s starting at age 70½.
  • You can roll your Solo 401(k) assets into IRAs or an employer’s 401(k) (if it is allowed by that employer’s 401(k).

Stay tuned for the next issue of The Solopreneur Retirement Fund Series where we will continue our discussion on more Solopreneur Retirement Funds options such as SEP, SEP IRAs, Roth IRAs, Self-Directed IRAs, and HSAs (Health Savings Accounts.)

Related:  Governments and Emojis Can’t Solve World Problems – We Can!


More from our lawyers: Well Wallet, PBC (aka WellWallet) is an informational platform for personal finance, and unless specifically stated otherwise, the content is provided to you without charge. WellWallet is not a financial planner, broker, or tax advisor. We cannot provide any advice for your specific financial situation. Our goal is to help you understand how to better manage your finances and how your finances affect your life goals, but we can never make any guarantees about your financial future (or present). The material here is meant for informational purposes only.  It should not be considered legal or financial advice. See our Terms & Conditions for more information.

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