What Freelancers Need to Know

Andrew Busa:

In today’s economy, freelancing is as important as ever. So how do you tap into your special skills to improve your financial plan? Listen to this podcast to find out how.

Andrew Busa:

Hello. This is Andrew Busa, and I’m a financial planner here at Adviser Investments. We’re here with another Adviser You Can Talk To Podcast. And today I’m joined by my colleague, JonPaul McBride. He’s a certified financial planner and a member of Adviser Investments’ financial planning team. Thanks for being here, JP.

JonPaul McBride:

Hey, Andrew. Good to be here.

Andrew Busa:

Excellent. So today’s episode is all about freelancing. And we’re super excited to bring this to you. As this new work-form, freelancing, becomes more prevalent, we think it’s very important that we’re able to give you some guidance in this area. Especially if you’re considering doing some freelancing, whether it’s part-time or full-time, during your working career, or even during retirement. But JP, why do you think this is important and relevant today?

JonPaul McBride:

Well, you kind of hit the nail on the head there. So according to Forbes, there are over 50 million freelancers in the United States right now.

Andrew Busa:

Wow.

JonPaul McBride:

And that number—yeah, exactly—is expected to actually grow, to close to a hundred million by the end of the decade. So the ranks of freelancers are already massive, and they’re growing. There’s also the fact that markets are unpredictable. A recession can happen at any time, as we now know. So it’s important to diversify, not only your portfolio, but also your income sources. It’s best not to put all your eggs in one basket.

Andrew Busa:

Yeah. No, I think that’s true. We talk a lot about the importance of diversification with your investments, but like you said, if you’re able to leverage some skill that you’ve built up over the course of your career to generate more income for yourself—as we’ll see through this episode—that can have a lot of benefits for your financial plan.

And I think that’s the structure that we want to take for today’s episode. We’ll start by defining exactly what freelancing is. And then we’re going to discuss freelancing within the context of a financial plan, just like we would build a financial plan for any client if they came to us saying, “Hey, I’m considering a freelancing position,” or “I want to do this full-time as my new job.” We’ll take you through that conversation that we would have with that hypothetical client. And we’ll tackle things like thinking about your income, your expenses, how this would change your net worth and account your saving strategies. And also we’ll touch on a little bit about insurance and how that would change as well. But anything else before we dive into that, JP?

JonPaul McBride:

No. Let’s do it.

Andrew Busa:

All right. So when you talk about freelancing with clients, how do you define it?

JonPaul McBride:

Yeah, there’s a lot of ways to skin the freelancing cat, but for the purposes of this conversation, we’re really thinking of consulting—so IT work, legal work, things like that. We’re also thinking about [things like] doing taxes seasonally, if you’re a CPA. Maybe it’s starting a small business or a private practice of some sort.

Andrew Busa:

Sure.

JonPaul McBride:

Or if you’re a teacher, it’s tutoring, right?

Andrew Busa:

Exactly, yeah. So kind of like we said before, you’re able to leverage a skill that you’ve honed throughout your career in order to generate income for yourself. And you’ll see through this episode as well, this is going to depend on whether the freelancing position is part-time or full-time. The financial planning considerations will change with that. So something to keep in mind and something that we’ll come back to throughout this episode. So starting off, within the context of someone’s financial plan, if you’re considering freelancing, income is a really good place to start with this. So, JP, take us through the income considerations when it comes to freelancing.

JonPaul McBride:

Yeah, yeah. So you’ve found your niche. You know what you’re going to do. You know that you’re going to make some money with whatever you’re pursuing. So the first thing to consider is you’re going to have more income coming in. That means more flexibility. And we’re going to bookmark that. It’s going to be a running theme throughout our conversation here and basically at every step of the way. So you’re going to have more flexibility. If you’re a younger client, if you’re a younger client that we see, you’re between the ages of 25 to 40 years old, this part of your life is all about wealth accumulation and goal planning and saving efficiently. It’s about getting on a good trajectory to set yourself up for success in the future. So having that additional source of income really could be the difference. It could help you accumulate faster, pay off student loan debt, maybe credit card debt, or maybe just afford a bigger house or a nicer vacation without going into debt, kind of all these little things that can set you up for success later on in life.

Andrew Busa:

Yeah, I think you bring up some really good points there. I think when you’re in that stage of your life and you’re considering doing some financial planning, if you’re able to generate even another two, three hundred dollars a month, say from some sort of a freelancing position, that can make a very large difference in your financial plan over the course of your life, whether like you said, you’re able to sock away more into your retirement accounts, or you can maybe afford a bigger house, like you said, a different lifestyle. That can make a very large difference. Flexibility, like you said, a key there. But as you move towards later in life, you’re still in the accumulation phase. Let’s say you’re in your forties now, but maybe you’ve transitioned from this freelance position, from being part-time to potentially now maybe it’s your full-time gig. You talk about potentially this idea of a mid-career break. Talk to us about that.

JonPaul McBride:

Yeah, yeah. We’ve had a lot of discussions with the MIT AgeLab here at Adviser, and that’s one of the things that they really stress, that you’re going to have a really long working career, and it’s not going to look level and even. It’s going to have dips and valleys and ebbs and flows. And there could be at this stage between 40 and 60 kind of a mid-career break or a reset where if you have this kind of marketable skill, you might want to transition to taking it from your side hustle to your full-time gig to have enough money to maintain your current lifestyle while you figure things out, while you decide whether or not this is the path that you want and you want to scale it up, but once again, it’s the flexibility thing. You want to make sure that you have enough flexibility to maintain your lifestyle. At this phase, you probably have children. You need to kind of maintain a lifestyle for their sake as well.

JonPaul McBride:

So that’s really kind of the thing that we want to stress here, is that that mid-career break or reset, having a side hustle could really be the difference. If you’re not, if you’re kind of continuing on as you are, that extra income could just help you reach retirement sooner. Maybe you can kind of pare back on your working arrangement. Or maybe someone could go part-time if your spouse wants to go part-time a little bit sooner. There’s a lot of ways that that extra income could help at this phase of your career.

Andrew Busa:

Right. And if it is a situation where you’re transitioning to being a full-time freelancer, there are other financial planning considerations here to keep in mind with regard to your income because potentially you’re going to be experiencing some fluctuations, where if you’re in a salaried position now, you’re getting paid potentially every two weeks, you’re used to that steady cash flow. If this becomes a situation where there’s more of an ebb and flow, something like your emergency fund is going to be very important here to your financial plan. We talk about three to six months of expenses typically being enough to kind of stem the tide if you needed to dip into that if you lost your job or something like that. If you’re considering freelancing full-time, I think six months is the minimum.

JonPaul McBride:

Yeah, definitely.

Andrew Busa:

You’re going to probably want to buffer that up to be even more, right?

JonPaul McBride:

Yeah, definitely, definitely. I was having a conversation with a client recently, and they were thinking about making this move, and they already had six months. And I said, “Well, maybe it’s nine months. Maybe it’s 12 months. You might want to bump it up just to be more conservative and keep that flexibility, keep those options open so that if things don’t come through or they slow down for a few months, you’re not stressing out.”

Andrew Busa:

Well, that’s a good talk through your 20s, through your 40s. Now, this is interesting, when you start to think about in your 60s and you’re getting closer to classic retirement age, but potentially wanting to still do some consulting, some freelancing. Talk about this category a little bit with regard to your income.

JonPaul McBride:

Yeah. And once again, going back to the MIT AgeLab, they said, “There’s only so much golf you can play.” So people are living more active retirements. They don’t necessarily want to go from 80 miles per hour, full speed, to zero right away. They want to kind of wind down over time. And freelancing or a side hustle can really help you do that. I actually [was speaking] with an 84-year-old adviser, who he was in the office most days, but he kind of clocked out when he wanted to. He took really extraordinarily long vacations to kind of sail and do whatever he wanted to do. It was kind of the best of both worlds. So kind of that slow wind down is really the key here when it comes to a freelancing or a part-time gig, a side hustle gig as you hit 60 plus.

Andrew Busa:

All right. So that’s a good overview of how freelancing could affect your income throughout your working career. But there’s the other side of the equation here with any position. That’s expenses. How does freelancing change that part of the equation?

JonPaul McBride:

Yeah, that’s right. Freelancing has a lot of income advantages, but it hasn’t been just when it comes to expenses too. For example, business deductions. Those were available to freelancers. If you’re working from home, you can kind of mark things off and deduct kind of the cost that can help you in the tax picture long run, over the long run.

Andrew Busa:

Yeah. I mean, organization here is key with regard to expenses really in a lot of ways because of taxes, right?

JonPaul McBride:

Exactly, exactly. So I mentioned that you’re going to have some deductions, but with more income, you’re going to have more taxes as well. And you definitely need to kind of get organized around tracking your taxes, making sure that you’re withholding taxes at the marginal rate, making sure that you’re setting it aside.

Andrew Busa:

And when you say marginal rate, give us a little bit of background there.

JonPaul McBride:

Of course. Of course. I mean, with more income comes more taxes. That’s just the way things work. If you’re at your main job, they’re withholding for you. You’re telling them, “I’m a single filer,” and they’re going to withhold at that single rate, and they’ll kind of do your work for you. But as a freelancer, this is your side hustle or potentially even your main hustle. You’re going to have to do that work yourself. You’re going to have to find your marginal rate and withhold your taxes. And that’s a little bit extra work, but it’s probably worth it in the long run for all the flexibility that you’re getting.

Andrew Busa:

Yeah. I mean, I think a key here with this section with regard to expenses is organization and being in good communication with your tax preparer or accountant. I think staying on top of cataloging your expenses, understanding where your money is going as you’re setting up your business, those are super important things to be aware of. We talk a lot about budgeting and the importance of making your money more efficient just for personal finance, but if you’re freelancing, organizing your expenses and keeping track of that, whether it’s your part-time job or eventually becomes your full-time job, is just really, really important.

JonPaul McBride:

It definitely is. And I think it’s an issue of scale too. If it’s a small side gig where you’re making a couple hundred dollars a month, it’s probably not going to change the picture that much, but-

Andrew Busa:

With regard to taxes.

JonPaul McBride:

With regard to taxes, yeah. If it’s your main occupation, you’re going to have to get used to quarterly payments for your taxes. And you may want to kind of hold back a few dollars just to make sure that you can kind of smooth out that payment over the course of the year.

Andrew Busa:

Yep, yep. That makes sense. So I think a key takeaway for this section here on expenses is just organization. Super important. You need to be able to know where your money is going. Work with your accountant to make sure that everything is on the up and up with regard to taxes, you’re doing everything correctly so you’re not surprised coming into the year if you’ve made a lot more money than you were originally expecting. So we’ve talked through income. We’ve talked through expenses. When you subtract income from expenses, you get savings, hopefully. So where do you direct that savings? And that’s where this plays into your net worth and your accounts. So discuss how freelancing has the potential to really change your net worth picture.

JonPaul McBride:

Yeah. There’s a lot of ways to maximize your savings. Maybe it’s increasing your cash reserve, but where we see the most impact is retirement savings. You can really kind of supercharge your balance sheet by maxing out your retirement accounts at work, but also maybe opening up some new retirement accounts on the side that will help you in the future.

Andrew Busa:

All right. So if freelancing eventually becomes your full-time job, then you need to get a little bit more serious about retirement plan selection, right?

JonPaul McBride:

Exactly, exactly. I mean, if freelancing and it’s your main gig, your employer isn’t sponsoring your retirement plan for you. You’re on your own. You’ve got to save for yourself. And so there’s a lot of different options, but the two ones that we want to highlight for you are the solo 401k and the SEP IRA.

Andrew Busa:

Right. So the solo 401k and the SAP, these are two options where if freelancing becomes your main position, these are two plans that you can consider, as you no longer have an employer-sponsored plan, you need to now fend for yourself. So talk through the solo 401k first.

JonPaul McBride:

Of course. Of course. So the solo 401k, it’s just like your traditional 401k. You’ve got a $19,500 employee contribution limit as of 2020 and a $6,500 catch-up if you’re over 50. You can also contribute basically up to 25% of your compensation that you receive from your freelancing up to a limit of $57,000, which is a great way to kind of supercharge your savings, right?

Andrew Busa:

Yeah, absolutely. I mean, that’s a huge way to be able to stuff more away if you have the income to do that. And also you’re lowering your tax liability. If they’re not Roth contributions, you’re lowering your tax liability for that year.

JonPaul McBride:

Exactly, exactly. And on the other side, one benefit of the solo 401k is you can actually choose to make the Roth contributions, so you can pay those taxes now. And in the future, distributions will come out tax-free, which is a great estate planning tool, a great way to kind of reduce required minimum distributions from your retirement plan in the future.

Andrew Busa:

Right. So the solo 401k definitely gives you some flexibility. You can make those traditional contributions, get the tax deferral now, or make those Roth contributions and get the tax-free growth later on in your career. So how does the SEP IRA stack up against the solo 401k?

JonPaul McBride:

So the SEP IRA, it’s a little bit different. A lot of folks who are sole proprietors still use the SEP IRA, but it really has kind of some scalability functions that are really nice. So once again, it functions like an IRA. It’s tax deferred. No Roth contributions for the SEP IRA. There’s still a $57,000 contribution limit as of 2020. And that’s basically up to 25% of your salary as an employer or 20% if you’re self employed. One thing that’s really kind of neat about the SEP IRA is that you can still contribute to another IRA. So you can really kind of max out on a lot of retirement savings in a way that you can’t with a solo 401k. You can kind of add on a separate traditional IRA. And the last thing I’ll probably note here is that if you have a kind of a scalable business, and you maybe have employees that you’re bringing on board, you can add them to your SEP IRA with kind of no muss or no fuss. As long as they meet some certain criteria, you can kind of help them save as well. So that’s kind of a really nice little added bonus to the SEP IRA.

Andrew Busa:

Right. The way I like to think about it between the two of these is that solo 401k is a little bit more complicated. It requires more administration, a little bit of work up front. And it’s really for those folks who don’t have any employees. The SEP is much simpler. You can start one very easily, and you still have the potential to sock a lot of money away and [it] can still work if you have employees. Beyond these two choices, there are other options to consider, like simple IRAs. There are even defined benefit plans, which is a totally different can of worms. We’ll save those for a different episode. But needless to say, talk to your adviser about these options, because it’s really going to depend how your business is structured, what your goals are, how much time you have between now and retirement.

Andrew Busa:

And also again, like we said, it’ll depend on if this is your main job or just a part-time job. If it’s part-time, it’s likely that you’re just going to be adding to your existing traditional IRA or Roth IRA if you’re eligible to do that. These options are really for people who are considering making freelancing their full-time job. I think that’s a key point, right?

JonPaul McBride:

Exactly, exactly.

Andrew Busa:

Yep. So we’ve talked through a lot of good information, and I think we would be remiss if we didn’t hit on insurance quickly because while it does lie separately outside of expenses and income and net worth, it is an important piece, maybe the most important piece, of your financial plan. And if you’re considering freelancing, it has to be considered seriously. So talk to us about this one, insurance.

JonPaul McBride:

Definitely. I had a friend who was going into private practice for counseling. And the first question I asked her actually was, “What’s your insurance like?” And she said, “Well, I don’t really have any insurance outside of work”. And I said, “Well, your first stop is go and get some malpractice insurance. Go and get some E and O insurance—errors and omissions insurance—because you want to make sure that you’re protecting your home assets and any other assets that you have from potential liability issues down the road.” So that’s kind of the first stop when it comes to kind of risk management and kind of making sure that you have protection.

Andrew Busa:

Sure. And I think this plays into also, if you’re working for an employer, and you have generous employee benefits, so you’re probably getting life insurance, you’re getting disability insurance, you’re getting a whole host of other fringe benefits. If freelancing becomes your main job, you’re likely not having access to those anymore. So JP, I think you bring up a good point, that all of those need to be reassessed. And your financial or adviser can help you think about that. If you’re potentially losing your disability coverage, for example, you’re a young worker earning a lot, you want to make sure that you’re covered for long-term disability insurance, for example. And we have other content on this. We’ve done podcasts on life insurance and disability insurance, and we can link those in the show notes here, but big picture, insurance is always something to consider, anytime you’re changing jobs, but especially if you’re really considering doing freelancing for your main gig, right?

JonPaul McBride:

Exactly. It’s going to be expensive. You’re going to have to go to the open marketplace for it. But that’s a pretty good problem to have.

Andrew Busa:

Exactly.

JonPaul McBride:

That means that your freelancing is working out, and you’ve got enough income coming in to make it your main hustle.

Andrew Busa:

Yeah. Well, I think you bring up a good point there. These things aren’t said with the purpose of being discouraging, or anything like that. It’s an excellent problem to have, like you said, if you’re able to kind of blossom this into extra income, a main gig where you’re making more than you ever thought you would. It’s just other parts of your financial plan to make sure that you’ve got kind of ticked and tied the right way. Just because, let’s face it, there’s liability in things that you might not even imagine that there are. So having the proper insurance coverage is really, really key to make sure that you’ve protected everything that you’ve built up.

JonPaul McBride:

That’s exactly right.

Andrew Busa:

All right. So we’ve talked through a lot of good information here, and I think we’ve barely probably scratched the surface on how freelancing can fit into your financial plan, but hopefully we’ve given you some good information. But JP, what are your biggest takeaways from this conversation?

JonPaul McBride:

Yeah, my biggest takeaways are first off, flexibility. Freelancing can be a great way to ensure the success of your plan long term by adding extra income. Another takeaway is make sure that you heed the tax man. You’re going to pay your taxes. You’re going to have some extra income coming, and you’re going to need to really set some money aside for taxes. And you want to protect yourself as well with the proper insurance and maybe even the proper business structure. We didn’t have time to go into that today, but maybe an LLC or a partnership of some sort would be the way to go to protect your assets.

Andrew Busa:

Yep. No, all good points. The thing for me, if it wasn’t clear throughout this episode, so much of this depends on where you are in your working career and also whether or not this is just a part-time gig for yourself or if it becomes a full-time job. Kind of those two factors are really going to change just what the recommendations are for you. So that’s why it’s important to loop your financial planner into this conversation. Because we can kind of tailor the conversation to you, specifically. We kind of gave high-level points on different categories of your financial plan, we talked about your income, your expenses, your net worth and your insurance, but this is really going to change depending on your specific situation. So do loop your financial professionals into this conversation. And we’re happy to assist and really tailor it to you.

Andrew Busa:

So, very good. This has been Andrew Busa and JonPaul McBride from Adviser Investments thanking you for listening to The Adviser You Can Talk To Podcast. If you enjoyed this conversation, please subscribe and review our show. We really encourage that. And we do take your feedback seriously. You can check us out at www.adviserinvestments.com/podcasts. If you have questions or topics you’d like us to explore, please email us at info@adviserinvestments.com. Thanks for listening.