This investment service piece explains the different Individual Retirement Accounts (IRAs) that 1099 contractors can take advantage of to save for retirement, providing pros and cons based on an individual’s retirement goals and financial situation. I was inspired to write this piece by my friends in the arts who are eager to save for retirement but don’t know where to begin. This piece was completed for Writing for Finance, Fall 2017.
Artists and Other Contractors: Choosing the Right Individual Retirement Account (IRA) for the Freelancer
Five years ago, Audrey Sarkisian was at the cast party for a production of Mozart’s opera The Marriage of Figaro. It was one of Audrey’s first professional gigs as an assistant stage manager, and she was beginning to understand the reality of being employed in the arts, beyond the romantic starving artist motifs, the glorification of non-traditional hours, and the camaraderie of her fellow backstage misfits.
That night the friendly conversation between the stage management team and one of the more established singers in the cast turned not to Mozart or the cultural relevance of Art with a capital A but to finances and retirement plans.
“I was just getting started in the business, and everyone I encountered had their own nugget of wisdom to share,” says Audrey, who is now a freelance stage manager and director. “But Andrew, who was singing Figaro and had been working as a freelance singer for 20 years, was the first person to stress the importance of starting to saving for retirement immediately, even in your mid-twenties.”
As an arts professional who works as an independent contractor or freelancer, Audrey would have to explore individual retirement plans to save for her future. But the need for an individual retirement plan is not just for artists.
More and more companies in all industries are hiring freelancers or contracted employees. In June 2017, Nasdaq reported that in 2016, almost 34% of the American workforce were freelancers. That number is expected to climb to 43% by 2020, meaning nearly one-half of the American workforce will be employed as freelancers or independent contractors.
As more and more individuals become employed as freelancers or independent contractors, fewer people will be able to take advantage employer-sponsored retirements plans such as 401(k)s and 403(b)s. Instead, they will have to plan and save for retirement by exploring other options.
Individual retirement accounts (IRAs) are some of the best options available to you if you are a freelancer or independent contractor who wants to save for retirement.
What is an IRA?
An IRA allows you to save for retirement while taking advantage of different tax benefits, depending on the type of IRA that is right for you.
The three types of IRAs
The three IRAs that are most beneficial for 1099 independent contractors are a Traditional IRA, a Roth IRA, and a Rollover IRA. Each IRA has its tax advantages, limitations, and guidelines that will help you match your circumstances, goals, and expectations with the IRA that is best for you. Regardless of the IRA you choose, every IRA has a maximum annual contribution of $5,500 before your 50 years old. Once you turn 50, your annual contribution increases by $1,000 to $6,500.
You pay into a Traditional IRA using pre-tax earnings, allowing your money to grow tax-deferred until you need to withdraw funds from the account in retirement. With a Traditional IRA, your earnings have the potential to grow faster, but you will have to pay taxes when you deduct contributions or earnings. For this reason, a Traditional IRA is recommended to those who anticipate being in a lower tax bracket when they retire. There are no income restrictions with a Traditional IRA – as long as you have an earned income, you can put money in your retirement account. However, if you need to withdraw from your retirement account before you turn 59 ½ years old, you may have to pay a 10% on all withdrawals. You can contribute to a traditional IRA until you’re 70 ½ years old, at which point the IRS requires that you begin taking Minimal Required Distributions (MRDs). The MRD on your Traditional IRA is determined by dividing the market value of your Traditional IRA on December 31 of the year prior by an applicable life expectancy factor. If your income is under a certain amount, you can fully or partially deduct your Traditional IRA.
You make contributions to a Roth IRA with after-tax earnings. Unlike with a Traditional IRA, when you are ready to withdraw money from a Roth IRA, you will not have to pay taxes on qualified withdrawals. For this reason, a Roth IRA is recommended if you anticipate being in a higher tax bracket when you retire. There are income restrictions with a Roth IRA. You can only make contributions to your IRA if your Modified Adjusted Gross Income (MAGI) is below a certain level. For example, as of 2017, you can make contributions to your Roth IRA if you made less than $118,000 in the previous year. Once you reach that income limit, you can’t contribute to the IRA until your income decreases or until it reaches the next limit, which was $133,000 in 2017. You can contribute to a Roth IRA at any age, as long as you are earning an income that does not exceed the limit. There are no MRDs with a Roth IRA account.
A Rollover IRA is a Traditional IRA used for money that has been transferred or “rolled over” from an employer-sponsored plan, like a 401(k) or 403(b), into an IRA. A Rollover IRA may be useful to you if you were once enrolled in an employer-sponsored plan but are now working as an independent contractor.
When should I open an IRA?
The sooner you can open an IRA account; the more money you will have in retirement. According to Fidelity, someone who contributes $5,500 for ten years starting at 25 will have more money at 65 than someone who contributes $5,500 for thirty years starting at 35.
As for Audrey, she didn’t exactly sprint from the party to the nearest bank. “I was 22 at the time, and while the rational part of me was saying, yes, do this now, retirement still seemed so far off,” she explained. “Five years later, and with a little more money in the bank, I finally opened a Roth IRA, with the expectation that I’ll be in a higher tax bracket when I get too old to stay awake for 2:00 a.m. production meetings.”