More than one in 10 Canadians are part of the gig economy workforce, and a further third are open to joining, according to a survey released this past April.
Given the volatile job market over the last two years of the pandemic, it’s no surprise more workers are seeking out flexible work that can help them balance their career and family needs and provide more autonomy and control.
[Read our blog post: Are you getting a pay cut by going back to the office?]
But there are trade-offs, too – less job security, no benefits, no paid holiday and crucially, no employer-funded retirement savings plan.
So what can freelancers do to better prepare for retirement? We’ve listed our top tips below.
1. Consider incorporation
While there’s a cost to setting up and maintaining a corporation, doing so will allow you to defer personal taxation on some or all of your income from your business activities. Any business income that is not withdrawn from the corporation will be kept as retained earnings and taxed at a corporate rate, which is much lower than your personal income tax rate. This may not be an option for everyone, but if you’re a freelancer earning an income in excess of $100,000, it’s almost a necessity.
In addition, you can choose how you receive your income. You can pay yourself a salary (and pay into CPP); pay yourself with dividends, which have better tax treatment than a salary, or take a blend of both.
The Canadian Pension Plan can be a valuable part of your retirement plan, especially for freelancers who may have had difficulty saving through their RRSP and TFSA. If you’re operating as a sole proprietor, you’ll be required to make both employee and employer contributions. However, for those who are incorporated, you will still need to pay both portions, but many opt to pay themselves a salary only up to the yearly maximum pensionable earnings for the Canada Pension Plan (CPP), to make the most of that program. For the remainder of their required personal income needs, they would then withdraw dividends, as they have better income tax treatment than a salary.
2. Pay yourself first
The older you are, the less time you will have to save, so your savings need to be higher than someone earlier on in their career. The power of compounding makes a monumental difference in both the amount you will need to save and the length of time you will need to do it. The earlier you start saving, the better.
How much to save depends on several factors. How much can you reasonably afford to save? What are your short and long-term financial goals and objectives? Do you know what your income needs will be in retirement?
If you have a consistent income, the best course of action is to set up an automatic savings plan and consider it an essential expense. Performing a cash flow analysis can help you determine a reasonable amount to contribute that aligns with your retirement goals. Sitting down with a financial planner to discuss these issues would certainly be beneficial.
For those with inconsistent incomes, it’s a little more tricky. You may want to consider setting up an automatic savings plan with the minimum amount you feel you can afford based on an average of your previous year’s earnings. If you can’t keep up with the automatic contributions, you can always reduce the amount, put them on hold or cancel them altogether. Ideally, you’ll be able to gradually increase these contributions as your income increases. You can also make lump-sum contributions when you’re able to build up some extra funds in your bank account.
[Read our blog: Why Amazon is a silent household budget killer
3. Set up a health spending account
If you’re incorporated, you can set up a health spending account (HSA) that allows you to make contributions from your company to an account that can be used for any CRA-approved health expenses (dental, vision, prescriptions, therapy, etc.). Unincorporated businesses including sole proprietorships and partnerships are eligible for an HSA plan only if they employ at least one arm's length (unrelated) employee who is full-time and has been continuously employed by the business for over three months.
Using an HSA means you’re using pre-tax funds from the company and not your personal income. However, some of the rules around single subscriber plans have recently changed. Your contribution amount is set annually and can’t be increased until renewal. Under the old rules, any unused contributions could accrue in the plan, which could help offset larger expenses in future years.
Now, all unused contributions must be returned to your company upon your annual renewal – effectively starting each year with a $0 balance. That being said, any unused contributions that are returned to your company through a health spending account could then be reallocated towards your retirement savings.
If you’re a sole proprietor that isn’t eligible for an HSA, you can apply for individual/family coverage through an insurance company, like Manulife’s CoverMe or through your local Chamber of Commerce. The downside to this type of coverage is that if your annual claims are less than your annual premiums, you lose money as nothing is returned to you at the end of the year. Also, if the claims meet or exceed the annual premium, the premium will likely increase the following year.
4. Know when it makes sense to contribute to your RRSP
If you aren’t incorporated, or you are but want to save for retirement outside of the corporation, an RRSP is an excellent financial planning tool. However, it may not always make the most financial sense to contribute. The benefit of contributing to an RRSP is to reduce your taxable income, effectively deferring paying income tax until you withdraw it, ideally in retirement. However, you may not have a high enough income to warrant its use.
There are a few downsides to using an RRSP. One is that the funds aren’t easily accessible and another is that any withdrawals will be taxable income in the year they are received. Additionally, that RRSP contribution room you used when initially depositing the funds will be lost forever. You could even end up in a higher tax bracket when you withdraw it.
[Read our blog: When you shouldn’t invest in your RRSPs]
As a freelancer, your income can be unpredictable. Let’s assume you are making automatic monthly contributions to an RRSP, and you start out the first six months of the year on track to meet your revenue targets. Then something out of your control slows you down during the second half of the year, and you fall well short of your income goals.
Aside from the obvious effects on your monthly cash flow, you wouldn’t have easy access to the funds you had been saving all year. Also, with a much lower income, the tax savings of those contributions will be much less. Instead, assuming you have the contribution room, make use of a TFSA. If you don’t have a great year in terms of income, you can access those funds without any tax implications, and you will regain the contribution room the following year.
Finally, if your income is in line with or exceeds your expectations, you can easily contribute the TFSA contributions you made during the year to your RRSP to get the tax deduction. Just remember to do it before Dec. 31st and not March 1st as the TFSA contribution room resets at the beginning of the calendar year.
Need help planning for retirement as a freelancer? I’d love to chat about your situation and develop a personalized plan to help you live out your retirement with confidence. Get in touch today to schedule a free consultation.