Today’s blog post for Lahrmer and Company, LLC is provided by Todd Pouliot at Gateway Financial:
It’s estimated that more than 53 million Americans are now part of the nation’s growing freelance workforce; this figure includes small-business owners, contract workers, consultants, and others who work on a project basis. Self-employed workers may enjoy the flexibility and control, but without help from an employer they often must take extra steps to strengthen their financial positions.
For starters, the typical emergency fund (three to six months worth of expenses) may be sufficient for a person with a stable salary, but a self-employed worker’s income can fluctuate. Freelancers might need to keep more funds in reserve to cover any earnings gaps. They are also on their own when it comes to shouldering health-care costs, meeting tax requirements, and saving money for retirement.
Self-employed individuals without access to workplace plans can buy coverage through the Health Insurance Marketplace. The premiums for high-deductible plans tend to be more affordable and may also be a deductible expense. Setting aside funds in a health savings account each month may help meet medical expenses and reduce taxable income at the same time.
Americans who don’t meet the individual health-care mandate face an annual penalty that is rising to the greater of $695 per adult or 2.5% of household income in 2016 (minors under age 18 trigger only 50% of the penalty). The maximum household dollar penalty in 2016 is capped at $2,085. Starting in 2017, the penalty will be indexed annually for inflation.
Sole proprietors and self-employed individuals who expect to owe $1,000 or more in federal taxes when filing their returns generally must make estimated tax payments. Calculations are typically based on the previous year’s tax liability.
Estimated tax payments for a given tax year are typically due in four equal installments: April 15, June 15, and September 15 of the current year, and January 15 of the following year. Unfortunately, penalties could begin accruing as soon as one quarterly payment is missed. The IRS charges interest daily until taxes are paid up. The annual rate is currently 3%, but subject to change each quarter.
Freelancers without access to employer-sponsored retirement plans may be able to contribute a larger portion of their incomes to their own tax-advantaged plans. Even better, retirement plan contributions are generally tax deductible as a business expense (including those made for employees).
A solo 401(k) is a one-participant plan that allows the owner of a business with no employees to make elective salary deferrals up to $18,000 in 2015 (plus a $6,000 catch-up if age 50 or older). As employer, the business can also contribute an additional 20% of the owner’s compensation (25% if the business is incorporated). Total elective deferrals and employer contributions (not counting catch-up contributions) are capped at $53,000 in 2015.
A SEP IRA (simplified employee pension) may be a good option for self-employed individuals, business owners who want to maximize contributions, and small businesses with mostly lower-paid employees. A uniform percentage of salary must be contributed to each eligible employee’s SEP IRA (including the owner), although the business is not required to make contributions every year. In 2015, contributions cannot exceed up to the lesser of 25% of compensation or $53,000. For self-employed individuals, the contribution limit is up to the lesser of $53,000 or 20% of net earnings from self-employment.
Employer-sponsored retirement plan distributions are generally taxed as ordinary income. Withdrawals prior to age 59½ may be subject to a 10% federal income tax penalty.
Todd Pouliot, AIF may be reached at 1 (844) 592-9888 or Tpouliot@sigmarep.com.