October 14, 2018

Freelancer Protections

You may have heard recently about California updating laws around who is an independent contractor versus an employee. People (and employers!) are confused about the difference. This is a common problem/discussion – especially in the freelancer world. The way the new laws are written is not what I want to talk about in this article – but the cause of this new law is.

Many, many people don’t have a good understanding of what it means to be a contractor, a freelancer, or independent from your employer. It is way more than just “paying your own taxes”. There has been a huge spike in people working freelance (think Lyft and the gig economy) in recent years and most of the lawsuits, like the one that started the new laws in California, revolve around one main idea:

Our social safety nets are designed around the employee/employer relationship.

That relationship, for many people, has changed faster than the government systems to protect people have. My intention is not to make an argument about government regulations, or charity/welfare systems, or redistribution of income. But I want to point out the fact that, if you are a freelancer, who works as an independent contractor, you do NOT have the same systems in place that an employee does. It is assumed that you understand this and have taken steps to protect yourself.

The trouble being, obviously, that most freelancers have NOT done this. So I’m going to try to lay out how to do that. Let’s look at the ‘Big Six”:

  1. Disability & Workers Compensation

  2. Healthcare

  3. Retirement Plans (401(k)s, etc)

  4. Retirement Income (Social Security)

  5. Unemployment

  6. Property and Liability Protection

 

1. Disability and Workers Compensation

This is a big one, and one of the most often missed. If you are an employee and are injured at work, you will have workers Comp to cover your medical bills and most states have a Disability Insurance structure – which will replace a portion of your wages for a short time if you are unable to work. Your employer is continually paying into these funds on your behalf. They are not perfect systems, but there is something there.

If you are a contractor, they are NOT paying this for you. So if you fall down a flight of steps while at work site, you are on your own. If you can’t perform on your contract, you don’t get paid. Granted – if you have medical bills, your health insurance (which you also didn’t get from your employer – but that is a conversation for later) should cover them. You’ll be on the hook for deductibles, co-pays, and co-insurance.

These systems (state disability and workers comp) are just big, statewide insurance policies. So, good news, you can go to an insurance company and just buy short-term disability. Aflac is the most common example of this (this is not an endorsement, I just know that is a famous brand). But many companies offer things like hospital insurance, accident insurance and short term disability insurance.

Remember that short term disability is not the same as long-term disability insurance. That may seem obvious but it is worth mentioning that these are two different policies, with different factors, costs, and benefit schedules. In a perfect world, you should have both – I do.

2. Healthcare

Not having employer sponsored healthcare has three different downsides: cost, deductibility, and access. Many people don’t realize that if they have insurance with their employer, in nearly all cases the employer is covering some, if not all, of the cost. So when if you have ever been laid off and had to buy “COBRA” insurance and you though “Holy crap COBRA insurance is so expensive!”. It isn’t – you are just now being forced to pay for the entire cost of your insurance yourself.

This is a fairly easy problem to fix – just count the dollars. When comparing a W-2 job to a freelance gig, make sure to take into account the value of benefits. Then it is easy to compare “apples to apples”.

When you have an employer plan you get to mostly pay for your insurance in “pre-tax” dollars – this makes it less expensive for you. If you don’t have that option as a freelancer you can still technically deduct the premiums – but it has to be more than 10% of your income to qualify for the medical expense deduction. And that amount (along with other itemized deductions) has to be more than the standard deduction. Under the new tax rules, this might not be possible – most people do NOT get to deduct their medical costs. That doesn’t get into the problem of if you have enough to even itemize!

Great news! This is one place where the Freelancer can actually outdo the W-2 worker. Because a W-2 worker only gets to deduct their premiums pre-tax – but  a freelancer (who does it RIGHT) can deduct all their medical costs pre-tax. You have to have a Small Business HRA plan to do it. I encourage you to check this out! Just know that you have to do some work to be able to get the same tax benefits a W-2 employee gets automatically.

The last area under healthcare is access. We could write novels about the Affordable Care Act. In fact we could write two – one about how it ruined all health insurance and the other how it saved people. Likely, both are true…. but that is for another day! For now, just know that one of the goals of the Affordable Care Act is to provide access. In the past, if you lost your job, you might lose your insurance. Or, if you didn’t have an employer sponsored plan, you had a harder time finding and buying insurance. One of the goals of the Affordable Care Act was to de-link the insurance from your employer. In this way, you could buy the insurance you need as a consumer on the public exchanges. As a freelancer, it is up to YOU to monitor this and make changes when necessary and ensure that you have the proper insurance for you and your family. Make sure that you are taking the time in the Open Enrollment periods to ensure you have the coverage you need!

There are also some groups that specialize in Freelancers. Check out Freelancer’s Union –  it helps freelancer’s get benefits. It is focused on New York state, but as it grows, I imagine it will help in lots of ways. They also cover way more than just health insurance.

Another great resource for finding insurance is ehealthinsurance.com – it can help you get some of the research done to find what you need.

3. Retirement Plans

This is another area (like healthcare) that has two different issues: access and employer contribution. The employer portion has the same solution as the healthcare – your employer might match a portion of your 401(k) contribution. This would just be considered compensation – whatever dollars are added in on your behalf can be included in your gross pay to find out how much you really make as a W-2 employee. As long as you are billing a similar number as a freelancer, you are good! (Just make sure to actually save it!).

The good news is that access can also be solved fairly easily, if you know where to go and what tools to use. I wrote a post about what accounts to use, but I’ll break it down in a condensed version here:

  • If you want to save less than $5k – use an IRA or a ROTH IRA.
  • If you want to save more than that (up to around $$40k a year) and you do NOT have an S-Corp, use a SEP IRA.
  • If you want to save more than $5k a year and you HAVE an S-Corp, you need to use a 401(k). This is easy to set up – I ONLY recommend that you use Guideline, which is linked to Gusto (WHO IS DOING YOUR PAYROLL AHEM.).
  • If you want to save  more than $50k a year you need a pension plan and professional who knows how to set them up and manage them. You cannot DIY them – please call me.

 

It doesn’t matter what type of account you use. Generally your best investment will be a low-cost, diversified portfolio of index/ETF funds. An IRA or a 401(k) is not an investment. It is a type of account – you still get to pick what investments you have in it.

 

4. Retirement Income

This should really be number 3.5 – since it is linked to retirement savings. But I thought I would call it out. The biggest difference between being a freelancer and a W-2 employee is how the treatment of payroll taxes. Payroll taxes, of course, refers to Medicare and Social Security taxes. The current rate of payroll taxes is about 15.5% – half of which is paid for by, the employee and the other half is paid for by your employer.

Wait – what if you don’t have an employer? Then you get to pay BOTH halves! This is called Self Employment tax (SE Tax) and If you have spent any time in freelancer world you have felt this sting. Yes, in many cases you have to pay MORE tax as a freelancer than as a W-2 employee.

 

If you have spent any time around me, you know that we can often use S-Corps to manage SE Tax. But it is important to remember that these taxes do actually go into the Medicare and Social Security system. If you never pay payroll taxes in your life, you will not be eligible for Social Security at retirement nor Medicare when you hit 65. I know, I know – that is a long way off and the system will be broke by the time you get there. I think this is pessimistic thinking – and for many people working multiple jobs to make ends meet in the gig economy – the equivalent today of a couple thousand bucks a month is a nice safety net for when they aren’t able to work as much later. As with all things – it takes money to make that happen. And you don’t get something for nothing.

 

So while managing tax today is a good thing, it is ALSO a good thing to balance that – in some cases the payroll taxes you pay are a good investment in your future. Never thought about it that way, huh? As a W-2 employee this system is automatic – you are opted in and will likely qualify whether you want to or not. As a freelancer – not so. And with that great power comes great responsibility.

 

This is often the part where I tell people that, yes, if you don’t want the great responsibility, maybe get a normal W-2 job – Which is totally fine! In America, with the American Dream motif, it assumed that working for yourself is somehow more noble than working a “lame desk job”. I think this is a mistake. I think the real dream is having the choice – the ability to pick what is best for you and your family.

 

5. Unemployment

This is another biggie that can be the most dangerous – because there is no real alternative system for freelancers. If you are laid off from work (not fired – this is not true if it is your fault you are fired) you can apply for unemployment. Your employer has paid an unemployment tax for you the entire time you have worked for them – everyone with employees does. All of that goes into a big pool and people who are laid off can get a small amount of money each week to tide them over while they find work. This turns what can be a catastrophic setback that you never recover from into something only slightly sucky.

 

As with all systems – it has its problems. But I doubt anyone disagrees with the spirit of the basic premise. But remember, it is paid into by employers, for their employees. If your project is cut, or hours reduced, or you are just plain canned (for ANY reason) from your contract job your income stops. Full stop, no more – all gone.

 

In the case of healthcare and retirement accounts and the like, there is DIY solutions that you can purchase to mimic the benefits that an employer provides. In this case, there isn’t. If you don’t have money saved you are screwed. With a capital S. Which means every check you get from your freelance gig you have to put aside a portion in savings. Not just because, since in general savings is good – but because NO ONE else is covering you! A freelancer needs a solid financial plan – it will be the difference between disaster and debt and solid financial footing. I would encourage you to check out my DIY Kit it gives you step by step instructions and worksheets to create and manage your own financial plan.

 

But even if you don’t want to get the kit – just remember when you bill that project, you must build in an amount that goes to savings – because the next project or gig might be a ways off.

 

6. Property and Liability Protection

This one can be easier – but many people don’t think about it. If you work at Starbucks and you break the coffee machine on accident, you might look like an idiot but no one expects you to buy a new multi-thousand dollar machine.

 

But if you are freelancer and someone at said Starbucks spills their latte on your MacBook (which is where you make your entire living) you are out of luck. And you are making no money until you buy another computer. Oh, you don’t have $3k lying around? Too bad. I guess it’s credit card debt for you!

 

But even worse – you are working on a client website – and your computer is logged into their back end system, which includes customer information. You leave your laptop unattended (dude, get OUT of Starbucks!) and someone swipes it. You could be on the hook for any liability that comes from the identity breach you just caused. You. Personally. On The Hook.

 

Call whoever does your car and/or renters homeowners insurance and tell them you need a “BOP” (Business Office Policy) or a rider on your home insurance that will cover at least your equipment. And consider getting a crime or cyber security policy. A $1MM umbrella liability isn’t a bad thing to get either…. They usually cost less than $100 a year.

In summary, if you are thinking “Holy Cow! Joe Freelancer bills the company $95 an hour for this stuff! I only make $6k a month in salary! I need to quit this desk crap!” start adding those things up:

  • What happens if you get hurt and your income stops?

  • Does your employer cover a portion of your insurance?

  • Do they match a piece of your 401(K)?

  • What happens if you lose your job entirely?

  • Will you have enough to retire on?

  • What happens if you fat finger something and take down the company store for three hours?

 

The cost of ALL those items is coming out of that $95 – so it might not be as sweet as you think. In many cases, it IS pretty sweet. I work from home and get to see my kids every day, nearly all day and it is ACES.

 

But that benefit, as with all things in this world, comes with costs. So as long as you understand the costs and how to manage them you’ll be all set!


freelancing Gig Economy Money Thoughts