More and more workers are leaving their full-time jobs and becoming part of the gig economy. Whether you are starting a consulting business working from home, a handyman service for seniors or creating an internet business, you are part of the gig economy.
What is the gig economy?
The gig economy is defined as a labor market where a large number of people work in flexible, temporary, or freelance positions.
Some people think this is a relatively new employee method, but it’s been with us for quite some time. We’ve seen this trend increase over the years due to less expensive and more widely used Internet services such as video conferencing. And it’s likely to continue to gain popularity, as it’s an agile method. Think of it as a just-in-time employment delivery where companies can ramp up or ramp down as needed.
If you’re in a position to start your own business, it can work really well for you. There are some significant advantages. It provides a more flexible work schedule and over time you can make more money. You just need to be cognizant of potential financial pitfalls.
The following are three financial tips if you are thinking about becoming part of the gig economy.
Consult with a CPA
One of the most common issues entrepreneurs face involves taxes. They end up under withholding and that causes a whole host of problems with the IRS.
For the self-employed, taxes include the standard income tax as well as a self-employment tax. This extra tax is usually a surprise to those who have recently gone on their own. The self-employment tax is both the employer and employee portion of Social Security and Medicare taxes.
So instead of working with a CPA after the fact to negotiate a settlement with the IRS, work with a CPA up front to learn the proper way to deal with taxes for your new business. Since you need to pay quarterly taxes, you need to put money aside each quarter to pay federal and state taxes. A CPA can help you come up with the appropriate amounts.
Continue to save for retirement
Another best practice is to work with a financial planner as soon as you start your company. When you start working for yourself, don’t forget to continue to put money away for retirement the same way you did with your company’s 401(k).
Freelancers can choose from several types of retirement savings accounts, including traditional IRAs, Roth IRAs, solo 401(k)s and SEP IRAs.
- A Roth IRA is a retirement-savings plan that allows you to invest with after-tax dollars. When you begin to make withdrawals, this money is tax-free on eligible withdrawals.
- A SEP IRA (Simplified Employee Pension) is a retirement plan designed for self-employed individuals and small-business owners. Similar to a 401(k), you can invest using pre-tax contributions, reducing your annual tax liability.
- Solo 401(k), or what the IRS calls a one-participant 401(k) is designed for self-employed workers with no employees.
Which one is best for you? Each of these have different eligibility rules, costs and levels of complexity to consider. By working with a financial advisor, they can guide you on the amount of money you should put away each year and the best vehicle to use for your situation.
Note: If your financial advisor provides comprehensive financial planning, they can also advise you on how to obtain health insurance. If you can extend your previous job’s coverage via COBRA or can be covered through your spouse or partner’s health plan, that’s great. But if you are on your own, your advisor can point you in the right direction.
Have an emergency savings account
Another best practice in navigating the gig economy is ensuring you have enough capital to get you by when things get slow. And things will slow down. Whether another economic crash happens like 2008 or the economy is put on hold due to a pandemic, there are always fluctuations in the market. When this happens, your business may take a hit. You need to have some capital set aside to get you through the downturn.
Work with an expert and they’ll guide you on the amount of money you should have to get you through the lean times. If you own a home, one thing we strongly recommend is that you get approved for a home equity line of credit (HELOC). Whether you think you need it or not, having a HELOC does not cost anything to get in place. And if you need to use it, you are only charged interest on the money borrowed.
Remember, working for yourself has a lot of advantages. Just be sure to avoid the financial pitfalls that go along with entrepreneurship. Follow these financial tips if you want to be successful in the gig economy. And listen to our podcast for more information.