There are more 1099 contractors in the workforce than ever before and their numbers continue to rise.
The term “1099” comes from a series of IRS documents that are designed to report income received outside of salaried employment. This can include investment returns, tax refunds, and income made as an independent contractor or freelancer.
The first thing to understand is that a 1099 contractor will most likely receive a smaller percentage of her paycheck as “take home” than a W2 employee. One major reason for the difference is that 1099 contractors often have to pay more for medical coverage, while W2 employees are oftentimes covered on their corporate health plan.
Another sizable hit that a 1099 contractor takes on her income comes from the Federal Insurance Contributions Act, or FICA. FICA consists of a payment for Social Security at 12.4 percent and a payment for Medicare at 2.9 percent. A W2 employee splits the cost of FICA with their employer, each paying 6.2 percent for Social Security and 1.45 percent for Medicare. An independent contractor, on the other hand, has to pay both sides of FICA as there is no employer to share the cost. This can really add up. In rough numbers, a person making $75,000 per year would have to pay almost $11,500 as an independent contractor in FICA alone, compared to just under $5,750 as a W2 salaried employee.
Independent contractors can also have a more difficult time saving for retirement. Similar to health insurance, there are advantages to being in a big “pool” when it comes to retirement. The primary disadvantage a 1099 contractor faces is the type of investment vehicles available. Many salaried employees have access to a 401(k) (or a similar retirement savings vehicle) through their company. Many of these plans encourage automatic contributions to be made directly from an individual’s paycheck, and some companies even incentivize those contributions through matching initiatives. Once again, the 1099 contractor has to go at it alone. The good news here is that independent contractors have access to several different types of retirement plans, and there is usually one that is a good fit for just about anyone. That said, the burden of finding a plan, and taking advantage of it once it is set up, lies with the individual.
David Posner is local investment executive specializing in utilizing socially responsible options for long-term financial goals.