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How Freelance Workers Can Stay on Top of Taxes

New services help you set aside money for retirement and other obligations

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Fluctuations in pay make it tricky to set aside the correct amount for your yearly tax bills.
Sergey Nivens/Alamy

When I filed my 2017 taxes last month, I was reminded what a scramble that process can be for freelancers like me. It’s not uncommon for self-employed workers to have to write big checks in April to cover federal and state income taxes. Then they have to write another one to fund their retirement plans.

The chief reason for the sticker shock: Freelance pay can fluctuate from year to year, so it can be difficult to estimate your annual total income in advance. One year you might work a seasonal job, for instance, and the next year tackle a series of part-time or contract assignments. Those fluctuations make setting aside the correct amount  for  your yearly tax bills tricky. Meanwhile, how much income you collect also directly affects the sum you can set aside in many retirement accounts.

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According to a recent T. Rowe Price study, 26 percent of boomers and 32 percent of Generation X respondents work independently in some capacity. Older independent workers can sometimes face stumbling blocks with these critical financial transfers without an employer automatically deducting taxes from each paycheck while funneling a percentage from the gross income to an employer-provided retirement plan.

Based on your previous year’s federal tax return, you (or your accountant) must figure out the total amount you will owe Uncle Sam on April 15, and how much you should pay in quarterly estimated taxes throughout the year. If your state has an income tax, you are also typically required to make estimated tax payments.

For federal returns, you can find the address for filing your payments and due dates as part of Form 1040-ES. You may face a penalty if you didn’t pay enough estimated tax for the year, or if you didn’t make the payments on time or in the required amount. You can avoid the penalty as long as you pay at least 90 percent of the tax for the current year, or 100 percent of the tax you owed for the previous year, whichever is smaller.

What I’ve found is that, even with the precarious nature of a freelancer’s finances, when you’re disciplined and automate the withdrawals from your paychecks on a regular basis, you can avoid the springtime surprise of a steep tax bill and save for retirement one paycheck at a time. Think cruise control.

If you pay your taxes via electronic filing, for instance, you can schedule all four estimated future quarterly payments at once and save yourself the headache of potentially forgetting to mail a check.

There are several promising money management apps designed to help you plan for taxes and retirement savings that you might want to investigate. Here's a look at three of them.

Track.Tax lets you link your bank account to the app, which scans for deposits that are self-employed income. The app is designed for anyone who receives income that will be reported on 1099 tax forms. Once you’ve signed up, it notifies you when new income is deposited into your personal bank account and asks if you’d like to withhold for federal income tax, state income tax and self-employment tax.

Track provides withholding suggestions on each of your 1099 income transactions. You can choose to withhold for some (or none) of these payments. You can set the app to automatically withhold for taxes, or you can manually trigger a withholding one deposit at a time. If you approve the withholding, it moves the amount it suggests to an FDIC-insured account that’s held in your name at the app’s banking partner, Evolve Bank. The app also has a feature that tracks your business expenses for potential tax deductions.

Track will send your estimated quarterly payments to the IRS and state government tax agencies for you, once you’ve approved the amount. The earmarked tax withholdings you authorize are held in your Evolve bank account for payment to the applicable tax body and cannot be returned.

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Cost: $10 a month after a free 30-day trial. If you choose the auto-file option, though, you will be charged $29 to file your quarterly tax estimates with the IRS.

Qapital is a free app that allows you to move a percentage of a deposit from your bank account to an FDIC-insured account at Wells Fargo, where it is held by Qapital. You can take the money from the account and transfer it back to your checking account whenever you opt to do so.

The app, designed in partnership with a Duke University behavioral economist, lets you name a savings goal and then apply “rules” to help you get there, using funds from your linked bank account.

For example, say your goal is to fund an IRA; your rule might be to divert 30 percent of any deposit you get above $1,000 to your selected savings account. Then you shift the funds to your IRA at a brokerage or fund company when you’re ready. There is no fee to use the app.

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Another company, Digit, offers a smartphone app that connects to your checking account, analyzes spending habits and every few days automatically sweeps a small amount of funds — typically between $5 and $50 — into an FDIC-insured bank-level encrypted Digit savings account. Your funds can be shifted at any time to your personal checking account within one business day. The service is free for 100 days, then $2.99 a month.

You can also set up a comparable do-it-yourself automated process with your own bank. That’s what I do. Each April, my accountant tells me the amount I need for quarterly tax estimates based on the previous year’s return. I divvy it up to sweep out a certain amount each month from my business checking account where my paychecks are deposited — usually electronically — and move it into a dedicated money market account. Not perfect, but at least it automates the process, and the funds are there when I need to tap them to pay my quarterly estimates. (If you have tried the Track app, you might consider taking its suggested withholding amount as your guide to how much you should transfer to the account you have set up at your own bank.)

For retirement fund contributions, I likewise electronically sweep a preset amount of funds each month from my business checking account into a money market fund and make my annual contribution at tax time. You might also make regular contributions routinely to a retirement account you already hold and boost it at tax time, if you have the option.

A few companies that employ gig workers are lending a hand with automated retirement savings. Lyft drivers can make IRA contributions through Honest Dollar by Goldman Sachs, and Uber has a similar arrangement with Betterment.

Freelancers who lack an employer retirement plan have a few savings options. You can put as much as $5,500 in 2018 (plus an additional $1,000 if you’re 50 or older) into a traditional or Roth IRA. With a traditional IRA, your contributions may be deductible if you aren’t covered by another employer plan, and the growth is tax-deferred. But if you have a spouse covered by a plan, income limits may apply; for more details, check the IRS website.

With a Roth IRA, your contributions are not tax-deductible, but your money grows tax-free, and you’ll pay no taxes on your distributions as long as you follow the withdrawal rules. (Normally, you must have held the account for five years and be 59½ or older.) Income limits for Roth IRAs: If you are married filing jointly, you must have modified adjusted gross incomes below $189,000 this year to make a full contribution. Single taxpayers must have a modified gross income below $120,000 to qualify.

A simplified employee pension or SEP-IRA is a tax-deductible retirement plan that’s appealing if you’re a single employee. For 2018 tax returns, you can contribute up to 25 percent of your compensation or $55,000.

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A one-participant or solo 401(k) is a retirement plan for self-employed people without employees (a spouse is an exception). This year, you can sock away, pre-tax, up to 25 percent of your pay, but your total contribution can’t surpass $55,000. If your spouse works with you, she or he can also put in the equivalent amount. If you’re unincorporated, your contribution limit is 20 percent of your income, after deducting half of the self-employment (FICA) tax.

These retirement accounts are offered at most mutual fund companies and brokerage firms. They’re easy to set up online — enter your bank information, how often you want to invest and the amount you want to transfer.

When it comes to hassle-free tax and retirement planning for self-employed workers — repeat this mantra — automate, automate, automate.

Kerry Hannon, AARP jobs expert, is the author of Great Jobs for Everyone 50 +: Finding Work that Keeps You Happy and Healthy … and Pays the BillsGetting the Job You Want After 50 for DummiesLove Your Job and What’s Next? Finding Your Passion and Your Dream Job in Your Forties, Fifties and BeyondFollow her on Twitter @kerryhannon.

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