Personal Finance | May 24, 2017

Independent Contractors: Is Your Money Working as Hard as You Are?

Key Points

  • As an independent worker, you’re in charge of your own business growth and your time, but you’re also in charge of your financial security.

  • Take it step by step, starting with an emergency fund and essential insurance.

  • The earlier you start to save and invest for retirement, the better.  

Dear Carrie,

I’m 26 years old and for the past three years I've been an independent hairstylist renting space in a salon. Fortunately, I've been able to grow my clientele and have saved some money, but what else should I be doing? I like being independent!  —A Reader

Dear Reader,

There's a lot to be said for independence. You're in charge of your own business growth and your time. That can be very freeing. On the flipside, you're in charge of your own financial security—from everyday things like emergencies to future concerns like retirement. That can be very scary.

As an employee, you often have the comfort and convenience of employer-sponsored health insurance and retirement plans. When you're an independent contractor, it's up to you to make sure you have those things covered. That all starts with saving, so it sounds like you're on the right track. But having money in the bank is only the first step. Now you have to decide where to put that money to maximize your ability to remain independent. Here's what I suggest.

Set up an emergency fund

This applies to everyone—independent contractor or not. What would you do if you have an accident or illness or if you suffer a business downturn? If you set aside cash to cover a minimum of three to six months of essential living expenses in a designated account that's easy to access, you'll know you can survive. It's fine to have a chunk in savings, but it's even better to know that you have a certain amount specifically earmarked for an emergency.

Make sure you have the right insurance

If you don't have health insurance, that's number one. Yes, you may think you're young and healthy and insurance is expensive, but consider that a single hospital stay could wipe out your savings. At the very least, get a high-deductible policy that would cover a catastrophic health event. Comparison shop, check out what's available on your state’s exchange, but whatever it takes, make sure you have it.

Next, look into liability insurance.  Regardless of how conscientious you are, things can go wrong.  Best to be safe and purchase a comprehensive policy that covers general (legal), professional (your work), and product liability. 

And finally, research disability insurance. An emergency fund will cover you if you can't work for a short time, but what happens if you're unable to work for an extended period? Social Security offers some coverage, but it's limited and the rules to qualify are quite strict. A private disability policy is an alternative worth looking into. It's not inexpensive, but if you intend to keep working independently, I'd recommend at least exploring your options.

Consider a health savings account (HSA)

While we're talking about health insurance, I'd like to suggest opening a health savings account. An HSA is available if you have a high-deductible health insurance policy. Current minimum deductibles are $1,300 for self-only coverage, $2,600 for a family.

An HSA makes sense because you can make tax-deductible contributions up to an annual maximum ($3,400 for a single, $6,750 for a family in 2017)—and then use that money to pay for qualified medical expenses, tax-free. If you don't use the total in any year, the money stays in the account and grows tax-deferred. You can withdraw funds for any reason penalty-free after age 65, but you'll pay ordinary income taxes on that type of withdrawal, just like with an IRA. Which brings me to the next important point.

Open a retirement account

When it comes to what to do with your savings, retirement should be at the top of your list. As an independent contractor, you have a few choices for retirement accounts:

  • Traditional IRA—Contributions may be tax-deductible and earnings grow tax-deferred. You can withdraw funds penalty-free after age 59½, but you'll pay ordinary income taxes on withdrawals. The annual contribution limit for 2017 is $5,500 ($6,500 if over age 50).
  • Roth IRA—If your income (in 2017) is under $133,000 for single filers or under $196,000 for married filing jointly, consider a Roth. You don't get the upfront tax deduction, but earnings grow tax-free and withdrawals are tax-free after age 59½. That can make sense if you expect to be in a higher tax bracket come retirement time. Contribution limits are the same as a traditional IRA.
  • SEP IRA—A SEP is easy to set up and allows for higher annual contribution limits—up to the lesser of 25% of compensation or $54,000 (2017).
  • Independent 401(k)—This involves a bit more set-up but has potentially higher contribution limits than a SEP.

I can't get into the details here, but an advisor at your financial institution could help you. You can also find information at At the very least, open an IRA and contribute the annual maximum. Start now in your 20s to put away just 10 percent of your annual earnings toward retirement, gradually increase that percentage 1-2% a year as you earn more money to target 15% and you'll be in pretty good shape. That percentage goes up dramatically the longer you wait.

Become an investor not just a saver

Don't stop with saving for retirement. Put that money to work by investing it in a diversified portfolio. An easy way to start is to buy a few shares of a broad based stock mutual fund or exchange traded fund (ETF). There's a lot of basic investing information online, but always be sure to ask questions and pay close attention to costs before you make a decision.

Keep up on estimated taxes

You're probably already on top of this, but for the record, as an independent contractor you're responsible for all self-employment taxes for Social Security and Medicare. The 2017 self-employment tax rate is 15.3 percent. You pay this by filing quarterly estimated taxes. Fail to file and you'll pay a penalty. (Hint: Put the dates on your calendar!) To keep your tax bite lower, itemize your business expenses and keep good records.

Be your own CFO

As an independent worker, you're your own boss but you also need to be your own CFO. That means carefully managing personal and business expenses both for the present and the long term. If you do that, you'll know you're on track for a financially secure future. That's the ultimate freedom.

Have a personal finance question? Email us at Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries contact Schwab.

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