Ironically, one of the most complicated tax brackets is populated by workers who appear to face some of the greatest uncertainty of ever being able to retire. The gig economy needs retirement plans.
In many cases, those who fall into this complicated tax bracket can enjoy substantially larger tax deductions than what full-time employees can get from 401(k) or 403(b) plans.
Note, however, that while the self-employed can’t avail themselves of 401(k) or 403(b) plans, people who are full-time employed can participate in any plan that doesn’t have the word “solo” before it — but they won’t get the same tax benefits.
Contributions exceeding the stated limits are also taxable — which shouldn’t deter you from investing if you have the ability. That said, here’s a look at the choices, beginning with the individual retirement account (IRA).
The Gig Economy Needs Retirement Plans
Traditional IRA
Maximum contribution in 2017: Up to $5,500 for those under 50 and $6,500 for those over 50, but see the catch below
Who can contribute: Anyone 69.5 years of age or younger
What’s the catch: That maximum contribution includes all retirement plan contributions to both the traditional IRA and Roth combined — but fortunately doesn’t include rollovers.
Simplified Employee Pension (SEP)
Maximum contribution in 2017: $41,000 or up to 25% of your net earnings, whichever is smaller
Who can contribute: Self-employed business owners only (but when there are employees who also want to participate, they get put into SIMPLE plans)
What’s the catch: This might not be the best plan for anyone intending to retire early; withdrawal of funds before age 59.5 might be subject to a 10% penalty along with applicable income taxes.
Solo 401(k) (a.k.a. Individual 401(k), Self-Employed 401(k) or Solo K)
Maximum contribution in 2017: $54,000 for those under 50, and $60,000 for those age 50 and up, but may not exceed 50% of a person’s net income earned through self-employment (a threshold that often gets confused)
Who can contribute: See below.
What’s the catch: As the second-newest type of retirement plan included in this article, this plan still isn’t offered by every single financial institution in existence. Plus, you might have to pay a special fee just to open the account.
Solo Pension (a.k.a. Solo Defined Benefit Plan)
Maximum contribution in 2017: Up to about $100,000 annually, depending on how you set the plan up
Who can contribute: If you can find an attorney or financial planner willing to draft the paperwork for you, then you can contribute.
What’s the catch: As the newest plan included here, this is also the hardest to find among financial institutions’ offerings (which may reflect the fact that pensions are becoming less prevalent due to the cost to employers). If it’s not a hybrid of a couple of other financial products, it might not go by the name you originally searched for.
Or it might actually be a repackaged annuity — not that there’s anything wrong with annuities per se, except for one important detail. Annuities have the highest sales commissions or any other type of financial product, only they’re paid to the sellers or brokers with the buyer even seeing them. Even if you trust your financial advisor, he or she has a greater incentive to peddle annuities than other types of financial products, regardless of whether they make the most sense for you.
(Solo) Roth IRA
Maximum contribution in 2017: $5,500 for those under 50; $6,500 for those 50 and up
Who can contribute in 2017: This one has the most complicated eligibility rules, but they include people who file as single and earn less than $133,000 annually; married couples who file jointly and together earn less than $196,000 annually; married individuals who file separately and have not lived with their spouse for a year while earning less than $133,000 annually; and married individuals who live with their spouses but are filing separately and have less than $10,000 annual earnings.
What’s the catch: That maximum contribution figure includes both what you contribute to a traditional IRA and a Roth.
Roth or IRA?
Most financial planners recommend you make full use of pre-tax retirement contributions before contributing to a Roth IRA — but reverse that if you believe your tax savings on the Roth will be greater when you retire. That might amount to an either-or decision in most cases.
Once you reach 70.5 years of age and can no longer contribute to an IRA, but still want to invest, you can keep contributing to a Roth. Also, if you’re within a few years of retirement yet have anything less than 100% of your portfolio in money market funds or municipal bonds, you might want to put half of your annual contribution into a Roth and the other half into a traditional IRA — as a way to hedge your bets on the tax savings issue.
If that last statement confused you in the slightest (why, yes, there are taxes in retirement) you have something in common with others who are still in the stage of life where they’re contributing to these plans rather than withdrawing. Unfortunately, oversimplified discussions about these plans can make that tax benefit sound like it means taxes are eliminated.
Sadly, none of the plans eliminate taxes, they just postpone them — with the sole exception being the Roth. The Roth inverts things, so you’re taxed before you contribute but then don’t pay taxes when it’s time to withdraw the money. This usually ends up being the biggest tax saving of all, assuming your investments appreciate in value.
And this brings up another important detail that is also misunderstood: You’re not allowed to postpone all of these taxes forever. Current IRS regulations state that once you reach the age of 70.5, you are required to start withdrawing at least a small percentage — known as a required minimum distribution — so that this money might be taxed as income, at your bracket. That is distinct from the capital gains tax rate.
You generally have to start taking required minimum distributions from retirement plans when you reach age 70½ — except that Roth IRAs do not require withdrawals until after the death of the owner when it passes to the chosen beneficiaries who in turn will also have to take the withdrawals.
You can learn the differences between all of the different types of retirement accounts on the IRS’ website — it’s worth bookmarking so that you can check back next year for the 2018 contribution limits.
Has this article convinced you that the gig economy needs retirement plans? And which one would you be most interested in using, readers?
Jackie Cohen
Jackie Cohen is an award winning financial journalist turned turned financial advisor obsessed with climate change risk, data and business. Jackie holds a B.A. Degree from Macalester College and an M.A. in English from Claremont Graduate University.
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