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The Tax Gift Every Freelancer Should Give Themselves Before December 31

Thanksgiving is just around the corner…which means the holiday season is about to kick into high gear with food, festivities and for many of us, giving gifts to family and friends. While being generous to others at this time of year is certainly in keeping with the spirit of the season, consider gifting yourself with a deposit in your retirement accounts—before you purchase a gift for anyone else on your holiday list and before the end of the year.

As a freelancer, moving yourself up to the top of your gift-giving list isn’t selfish. In fact, cutting yourself a check for your Individual Retirement Account (IRA), SEP IRA, Solo or traditional 401(k), and other qualified retirement savings accounts before December 31 is one of the best gifts you can give yourself that will also benefit others. This is because by contributing to your retirement savings now, you’ll ensure that you are able to retire with financial security—instead of freeloading from friends and family in the future. Plus, you’ll be saving 2019 tax dollars in the process, which means you’ll have more cash to save for those inevitable dry spells which all freelancers face from time to time.

Here’s your freelance retirement contribution gift list.

Depending on how your freelance situation is structured, there are several ways to gift yourself retirement savings. If you haven’t set up a retirement account, now is the perfect time to do it.

For freelancers with minimal retirement budgets, a traditional IRA is the best way to start off. A traditional IRA is the easiest type of retirement account to use and allows you to take a tax deduction for your contribution in the year that you make it (hence the importance of investing now, before the 2019 tax deadline). You will pay tax on this money when you withdraw it in the future as retirement income.

Another important point to keep in mind is that the rules for retirement savings changed under tax reform this year and they may even allow you to put away a little more money tax-free:

  • In 2019 there was an increase from $5,500 to $6,000 in the amount you can contribute to an IRA. There is not an increase in the additional catch-up contribution limits allowed for individuals aged 50 and over—it remains $1,000.
  • There are increases in the income ranges for determining eligibility to make deductible contributions to traditional IRAs and to claim the saver’s credit. The increases are detailed here:
  • If you are a single freelancer without an employer-sponsored retirement plan, then you likely don’t need to worry about the phase-out limits (although checking with a tax professional is a good idea). However, if you are single or married and during the year either you or your spouse was covered by a retirement plan at work, your eligible deductions may be reduced until it is eliminated, depending on your filing status and income.

The traditional IRA phase-out ranges for 2019:

  • For single taxpayers covered by a workplace retirement plan: $64,000 to $74,000, up from $63,000 to $73,000.
  • For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan: $103,000 to $123,000, up from $101,000 to $121,000.
  • For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out at $193,000 and $203,000, up from $189,000 and $199,000.
  • For a married individual filing a separate return who is covered by a workplace retirement plan, there is no adjustment. The phase out remains $0 to $10,000.

For freelancers who can save more for retirement, consider a Solo 401(k) or a SEP IRA. A Solo 401(k) plan allows a self-employed business owner to make contributions as both the employee and the employer. In comparison, a SEP (Simplified Employee Pension) IRA allows profit-sharing contributions only. If you make around $250,000 a year, you can essentially contribute the same to either type of account—here’s the fine print on both of them:

According to the IRS, the owner of a Solo 401(k) can contribute both:

  • Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit of $19,000 in 2019 or $25,000 in 2019 if age 50 or over. In 2020, the limits are $19,500 or $26,000 if age 50 or over.
  • Employer nonelective contributions up to 25% of compensation as defined by the plan, or for self-employed individuals (not counting catch-up contributions for those age 50 and over) a maximum of $57,000 in 2019 ($56,000 for 2020).

In both of these cases the limit is 20% of revenue for a sole proprietorship or single member LLC.

As an alternative profit-sharing vehicle, a SEP IRA may also be beneficial for freelancers. Even if you work solo, you may want to consider a SEP IRA over a traditional IRA because the annual contribution limits are significantly higher. In 2019 you can contribute the lesser of:

  • 25% of your compensation (with a $280,000 ceiling for the calculation in 2019) or $56,000.
  • In 2020, the ceiling is $285,000 and the limit is $57,000.

Keep in mind that if you contribute to a SEP IRA for yourself, the IRS requires you to contribute to the SEP IRA of every eligible employee at the same the percentage of compensation you contribute toward your own. To be eligible, employees must:

  • Be at least 21 years old
  • Have worked for you during three of the last five years
  • Earned at least $600 from you in the past year

There are new contribution limits for those who are traditionally employed.

If you are a W-2 employee as well as a freelancer, there is a $500 bump up in the contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. The increase is from $18,500 to $19,000.

Contributing to an employer-sponsored 401(k) plan will net you tax savings as well as a potential employer match—which is a gift of free money. If possible, max out your contributions to take full advantage of this benefit.

Check your freelance retirement savings off your gift list before December 31

A lower tax bill and a more secure financial future are two things every freelancer can use. Making your retirement contributions now, before you get hit with bills and tax season is a smart move—and is likely to give you more peace of mind than any other gift this holiday season.

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Jonathan Medows, CPA

Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.

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