The Free Application for Federal Student Aid, more commonly known as FAFSA, is the gateway to most types of college financial aid. This application asks questions about the student and family’s financial situation to assess financial needs. The federal government, state governments, and individual schools use the information to determine your financial aid award.

Am I Eligible For Financial Aid?

Most students are eligible for at least some financial aid. However, you must have completed high school or the equivalent and enrolled in a degree-seeking program. You also must be a U.S. citizen, U.S. national, or eligible non-citizen with a Social Security Number. In addition, you must not be in default on previous federal student loans, and you must not have received any drug convictions while receiving federal student aid in the past. Some types of financial aid, like grants and subsidized student loans, are based on financial need. Therefore, your eligibility for these types of assistance will depend on the answers you provide in the FAFSA. However, other kinds of financial aid, like unsubsidized student loans and parent loans, are available to all eligible applicants, regardless of financial need.

What Types of Aid Are Available?

How and When do I Apply?

You need to apply before each school year for which you want to receive financial aid. Fill out the application at FAFSA.ed.gov as early as January 1st of the calendar year in which the school year begins. For example, if you are applying for aid for the 2022-23 school year, you can submit the FAFSA as early as January 1st, 2022. The federal deadline for the application is June 30th at the end of the school year, although states and schools often have earlier deadlines. You will need a prior-year tax return and W-2 statements to fill out the application correctly. You will also need current bank statements and records of any other investments. If you are a dependent student, as most undergraduates are, you will also need your parents’ financial information.

What Happens After I Apply?

As soon as you complete your FAFSA, it goes into the processing stage. Each college you list on the FAFSA will receive your information the following day. Then, you will receive a Student Aid Report (SAR) via email about 3 to 5 days after you submit the FAFSA. The SAR will tell you your Estimated Family Contribution (EFC) if your application is complete. That is the amount the federal formulas determine your family should pay for this year of college. Your college will use your EFC to determine your exact financial aid award. If you did complete your application, the SAR would let you know what you need to do to finish it.

FAFSA and You

View Resource FAFSA and You
College graduates often leave their universities with an unwelcome burden — a significant amount of debt. It is important to note how much student debt has grown over the last five years. According to EducationData.org’s latest report, student loan debt has increased from $1.05 trillion in 2012 to $1.745 trillion in 2022. And according to that same report, the average student loan debt is currently at $40,780. That means that the odds are good that college graduates will leave school with at least some debt to repay. It says, too, that paying back this amount of debt will be problematic for some graduates who struggle after entering the workforce to find jobs that pay decent wages. The good news is that there are options for graduates who cannot afford their monthly student loan payments. The bad news? Those graduates who ignore these possibilities could face serious financial consequences.

Don’t Ignore It

The worst move college graduates can make when their student-loan debt becomes overwhelming is to ignore the problem. It is tempting for students to ignore their late bills and hope that the problem goes away. However, it will not. Graduates who do not make their student loan payments on time could face severe financial penalties. They will also see their credit scores take a hit. That is terrible news: Lenders of all kinds — mortgage, auto, and personal — rely on these scores when determining who gets loans and at what interest rates. The borrowers with low credit scores will either not qualify for loans or credit cards or have sky-high interest rates for loans they can obtain. So what should graduates do if their loan payments become too much of a burden? First, they should call their lenders. That might be embarrassing, but lenders will often work with graduates to come up with a solution to their financial woes.

Consolidation

Many graduates choose to consolidate their student loans. Under consolidation, multiple loans get combined into one. That simplifies paying back these loans: Graduates now have to make just one payment every month. Consolidation can also lower the monthly payments of graduates because the process gives them up to 30 years to repay their loans. The downside? Graduates who increase the length of their repayment period will pay far more in interest during the life of their student loan debt. That is why loan consolidation is not always the best financial solution for college graduates.

Postpone

Some lenders might allow graduates to postpone their loan payments during unemployment or other financial crises. That gives graduates extra time to shore up their finances or find a better-paying job. The problem? Adding months to the lifespan of a student loan means that borrowers will usually have to pay more interest over the life of the loan. The best way to handle student loan debt is to pay it back as quickly as possible. Postponements instead make debtors spend more months paying back their loans.

Payment Plans

Another option for borrowers is to request a new payment plan from their lenders. Lenders might be willing to lower the money that borrowers have to pay each month. They might also help reduce the interest rate attached to the loan. Borrowers who took out federal student loans might qualify for income-contingent repayment plans. Under these plans, graduates only pay a monthly payment of a set percentage of their monthly incomes. Such plans are a boon for borrowers whose monthly incomes are low.

Alternatives

Graduates can also sign up for specific careers or programs to reduce the student loan debt they owe. For instance, graduates who signup for the Peace Corps can eliminate 70 percent of their student loan debt from Perkins loans. In addition, those who took out Stafford and consolidated loans can receive a deferment of up to 27 months. Graduates who sign up as volunteers for Americorps can receive nearly $5,000 to pay off their student loans after one year of service. Facing monthly student loan payments can prove stressful to recent college graduates. Moreover, graduates struggling to find good-paying work in their field will face even more stress when those student loan payments come due. However, students who want to overcome their debt will have to be proactive. There are options out there. It is up to graduates to do the research necessary to find the best ones.

Living with High Student Loan Obligations

View Resource Living with High Student Loan Obligations
Making monthly student loan payments is about as much fun as going to the dentist. According to EducationData.org, 64 percent of today’s college students went into debt after graduating with roughly $40,780 on average. Student loan debt totals at $1.745 trillion, a 3.5 percent increase from the year prior. As tuition costs rise and student loan debt balances grow for new graduates, it might feel like paying off that student loan is something you will never get behind you.

Strategies

The good news is that you are permitted to repay your student loans at a faster rate than the maximum 10-year timeline that federal loans allow. In other words, there is no penalty for repaying them early. Additionally, following a more rapid repayment strategy would result in lower interest costs than if you conformed to the standard repayment term. These rapid repayment strategies will help you repay your student loans quickly so that you can move on with life without student loan debt weighing you down.

Prioritize Payoff Concentrations

Many people have multiple student loans with different repayment requirements, interest rates, and terms. As you put together a repayment strategy, you will want to examine all of your student debts closely and, while paying the minimum due on each student loan, you will want to prioritize repaying the debt that will cost the most first. That means you will pay the minimum balance on all other student loans while paying as much as you can on the one that carries the highest interest rate or least favorable terms. You will especially want to do this if you have any student loans with a variable interest rate. Paying those loans off early, before rates increase, should be a top priority. If you have high-interest-rate loans or massive student loan debt, the savings you stand to gain from this tactic can be substantial. However, once you finish paying off one loan, it is time to move on to the next – and then the next. Paying off each successive loan should be faster as you apply the monthly payment you made on a paid-off debt to the next one. Keep doing this until all student loans reach a zero balance.

Consolidate Student Loans

Consider consolidating your student loans if you have an excellent credit score and high-interest rate loans. Not only will that simplify the repayment process, providing you with a single bill to pay each month, but it can also substantially reduce your interest rate.

Take Advantage of Your Job if Possible

Some employers offer student loan assistance programs in their benefits packages. But, taking some jobs may actually qualify you for student loan forgiveness. There may be regional requirements or time of service requirements, but people working in the following professions may be eligible for forgiveness programs: Even if you qualify to have only a portion of your student loans repaid by someone else or forgiven, it can mean a massive reduction in your overall debt. In addition, loan forgiveness can help you repay your outstanding debt balance that much faster.

Change Your Financial Circumstances

Putting extra finances towards student loan repayment will have you pay off your debt in a shorter time frame, which is much quicker than sticking to the minimum payments for the next 10 or 20 years. Of course, making more money is not the only way to put more towards your student loan payments. You may also choose to cut unnecessary expenses from your budget and invest those savings toward eliminating your student loan debt. Easy starting places include the following: The key is to reinvest your savings into paying off your student loans faster. You will be surprised by how quickly the little things add up.

Caveats

There is one key point to remember before you dive too deep into your efforts to pay off your student loans faster. Be cautious of some government programs designed to ease the pain of student loan payments. They often provide you with the means to reduce your monthly payments, simplify your record-keeping, and only make one payment each month. However, that convenience typically comes at the high cost of extended repayment terms on your loan. Since the goal is to repay your student loan debt faster, not lengthen the amount of time you must continue to pay this debt, these government programs might not be your best choice. In addition, extended repayment periods often mean you will pay more interest over time. Quickly paying off your student loans frees up your money and attention for far more enjoyable pursuits. The strategies and tips above will help.

How to Quickly Pay Off Your Student Loans

View Resource How to Quickly Pay Off Your Student Loans
Are you saving enough for retirement? If you are like most U.S. residents, probably not. The Employee Benefit Research Institute’s 2022 Retirement Confidence Survey reports that slightly more than 7 in 10 works are confident in having enough saved to live comfortably in retirement. In addition, slightly more than half of workers report that the COVID-19 pandemic has not changed their confidence in their ability to live comfortably throughout retirement. However, roughly a third of workers that are less confident in their ability to save for retirement cites that inflation and the increase in cost of living are the reason. Despite all this, two-thirds of workers are still confident in their ability to cover basic expenses and medical expenses during their retirement. However, confidence in a comfortable retirement is also firmly based on whether survey respondents had a retirement plan in place. For example, 73 percent of workers are very or somewhat confident that they’ll have enough money to live comfortably in retirement, with 28 percent being very confident. The good news is that you can avoid falling into this ‘confidence trap’ by preparing yourself for retirement now. The key is to assess your retirement needs early by determining what lifestyle you want to live and how much money you need each year to afford it. Then start saving money as early as possible and learn the basics of the various retirement-savings vehicles available to you.

Assessing Your Retirement Needs

The Retirement Confidence Survey also reports that 60 percent of workers have began to receive information from their employers regarding their projected monthly income in retirement. Not calculating how much you’ll need is a worker’s biggest mistake as their retirement years draw closer. If you do not know how much money you will need to live the lifestyle you want in your retirement years, you are far less likely to save enough money each month to reach these goals. The amount of money you need to save each month will vary depending on your goals. For example, your savings needs will differ depending on whether you want to travel the globe after retirement or prefer to spend your post-work days visiting your grandchildren who live less than an hour’s drive away. Know, too, that your health will play a significant factor in how much you will need to live comfortably after retirement. If you or your spouse require a considerable amount of medical care, your savings, no matter how much insurance coverage you have, will be more likely to dwindle at a faster rate. Most people rely on three sources of funding for their retirement years: Combining these three funding streams must equal or be larger than the amount of money that you determine you need each year to live comfortably in your retirement.

Starting Early

The best move is to start saving for retirement as early as possible. The later you wait, the more difficult it will be to save enough. In their article Penny Saved, Penny Earned, Vanguard Group researchers Maria Bruno and Yan Zilbering show how vital saving early is. According to their research, investors who saved 6 percent of their salaries in a portfolio split evenly between stocks and bonds starting at age 25 enjoyed a median portfolio balance at retirement of nearly $360,000. That figure fell to $237,000 for investors who waited until 35 to start investing and $128,000 for those who waited until age 45. The message here is simple: It is never too early to save for retirement. Those workers in their 20s and early 30s might be especially well-suited for saving for retirement. Setting aside retirement money once children, mortgage payments, and auto loans enter the picture becomes more challenging. However, young workers who get into the habit of saving early for retirement will be more likely to continue their savings even as their monthly expenses rise.

Retirement-Savings Vehicles

If you have decided to boost your retirement savings, the good news is that you have plenty of financial vehicles to choose from when saving for your retirement years. While pension plans are becoming rarities, many workers do have the option of participating in their company’s 401(k) plan. If your company offers such a plan, you will be wise to participate and contribute as much of each paycheck as allowed. The more you save each month, the more comfortable you will be in your retirement years. An Individual Retirement Account, better known as an IRA, is probably the best known of these vehicles. If your employer does not offer a retirement plan, you can deduct your contributions to a traditional IRA from your gross income. That pays off at tax time; you will pay lower taxes because your reported income will be lower. However, your contributions to an IRA are not deductible if you have a retirement plan at work. You can start withdrawing money from an IRA at the age of 59-and-a-half without paying any penalties. When you withdraw money from a traditional IRA, though, you will pay taxes. A Roth IRA operates differently. The contributions to a Roth IRA are never tax-deductible, but the earnings on these contributions grow tax-free. Meaning, you end up paying taxes when you contribute money to a Roth IRA, but you do not pay them when you withdraw it. You can also withdraw money from a Roth IRA before turning 59-and-a-half and not pay any penalties. There is one thing that both Roth and traditional IRAs do have in common: The money you deposit in both types of IRAs will grow tax-free. IRAs are a significant source of retirement savings. However, investors can also earn retirement income through such savings vehicles as stocks, bonds, and annuities. The best plan is to rely on several types of retirement savings vehicles. That way, if one type does not perform well — say the stock market falters — your other vehicles can help cushion the blow.

The Basic Principles of Retirement Planning

View Resource The Basic Principles of Retirement Planning
A strong economy, coupled with a rising stock market, provided steady increases in the average 401(k) account between 2010 and 2020. That trend seemed to continue in 2021, however, account balances began to shrink due to market volatility and inflation in 2022. According to a 2022 Fidelity Q3 Retirement Analysis, the average 401(k) balance decreased by 23% from $126,000 in Q3 of 2021 to $97,200. In addition, the average IRA balance went from $136,000 in Q3 2021 to $102,000 in Q3 2022. Most workers know that there is little that they can do to improve the country’s economic performance, and predicting the stock market’s performance is a challenging task. What workers know they can do is to focus on their retirement savings strategy. With the proper focus, your retirement years can be comfortable, allowing you to travel, spend time with your grandchildren or take up new hobbies. However, this will not happen if you spend these years worrying about money. Fortunately, you can boost the odds of a happy retirement by avoiding some of the most common retirement savings mistakes.

New Workers

Not saving early enough: It is easy to forget about planning for retirement when you first start working. After all, you have other expenses — rent, maybe a mortgage, furniture, clothing — that you need to cover. With that said, those who start saving early for retirement will end up with significantly more money in their retirement years. In their article Penny Saved, Penny Earned, Vanguard Group researchers Maria Bruno and Yan Zilbering show how vital saving early is. According to their research, investors who saved 6 percent of their salaries in a portfolio split evenly between stocks and bonds starting at age 25 enjoyed a median portfolio balance at retirement of nearly $360,000. That figure fell to $237,000 for investors who waited until 35 to start investing and $128,000 for those who waited until age 45. Not maximizing the match: If you work for a company that offers a 401(k) program, you need to participate in it. These programs provide a relatively pain-free way to build your retirement savings over time. Don’t make a mistake many young workers make, though: Maximize your employer’s match. You will miss those extra dollars when retirement arrives if you do not. Running up debts: It is easy to run up credit card debt. However, remember, it is not easy to comfortably retire when carrying a heavy debt burden. Begin wise spending habits — only charge what you can afford to pay back when your next credit card statement arrives — at a young age. They can save you a world of financial pain as retirement nears.

Middle-Age Workers

Borrowing money from your retirement accounts: Borrowing money from your retirement accounts is a terrible financial decision. You will sometimes pay severe tax penalties to withdraw funds early from these accounts. Even worse, though, is the toll early withdrawals take on your future savings. If you remove money from your retirement accounts, these dollars do not get a chance to grow at a compounded rate. As a result, you will end up with far less money at retirement age. Putting college before retirement: It is natural that many parents want to help their children pay for their college educations. However, remember this: Your children can take advantage of student loans and grants to get through college. They then have their entire lives to pay back their college debt. If you spend your retirement dollars to help fund your children’s education, though, you will face severe financial consequences once you stop working. Not diversifying: The best way to save money for retirement is by creating a diversified portfolio of stocks, bonds, and other savings vehicles. This way, if one savings vehicle suffers — the stock market crashes, for instance — your other investments will remain strong. But, unfortunately, too many investors put all their dollars into one type of investment, either incurring too much risk or not enough.

Nearing Retirement Age

Underestimating medical expenses: Too many people think they will remain healthy throughout their retirement years. Unfortunately, that often doesn’t happen, and not planning for medical expenses can prove a costly mistake. Fidelity estimated that most retirees should expect to pay roughly $315,000 in medical costs during their retirement years. Underestimating their lifespans: We are living longer today. That is good news. However, it also means that you will want to save more money for retirement. Don’t mistake thinking that your retirement will be a relatively short one. If you leave work at age 66, you might have 30 years of retirement living to fund. Retiring too early: Full Social Security benefits kick in at age 66.The longer you put off retiring, though, the higher your annual benefits will be. If you can keep working, it makes financial sense to push off retirement as long as possible.

Retirement

Withdrawing too much too early: Once you retire, don’t make the mistake of withdrawing too many dollars from your retirement savings too early. Instead, financial planners advise that retirees follow the 4 percent rule: Only withdraw 4 percent of your retirement savings each year.

Retirement Planning Mistakes to Avoid

View Resource Retirement Planning Mistakes to Avoid
The Employee Benefit Research Institute’s 2022 Retirement Confidence Survey reports that 7 in 10 workers are at least somewhat confident in their ability to live comfortably in retirement. There’s been an increase in worker confidence comes from an increasing belief that they will have the ability to handle one of the basic expenses in retirement — their health care. But that also means that 3 in 10 workers are not confident that they will have saved enough. If those currently in the workforce follow the same path, they will face a painful reality when they reach retirement age: Social Security provides far from enough income for people in their retirement years. Those who do not save enough will spend these years worrying about paying their bills. The truth is, retirement is not inexpensive, even if you do not have a mortgage to pay or significant credit card debt. Consider medical costs. The Fidelity Retiree Health Care Cost Estimate found that a couple retiring in 2022 at age 65 with no employer-provided health care coverage will need $315,000 in savings to fund out-of-pocket medical expenses during their retirement years. The good news? Even if you have been lax in saving for retirement, you can still take steps to increase the amount of money available to you after you quit working. Here is what you should be doing at every stage of your working life to save for retirement.

Just Getting Started

Admittedly, it is not easy to think about saving for retirement when you are just getting started on your job. However, there are specific steps you can take today to boost the odds that you will have enough money to enjoy your retirement years. Step one? Participate in your company’s 401(k) plan if it offers one. Moreover, participate completely; max out your regular contributions. You will not miss money that is deducted from your paycheck automatically. However, you will undoubtedly appreciate it once you retire. Next, invest in a traditional or Roth IRA or a combination of the two. That allows you to save money for your retirement years on a tax-deferred basis. The other important step to take at this stage? Practice sound financial habits. You do not want to enter your retirement years burdened by credit card debt. The less consumer debt you generate during your 20s, the better off you will be as retirement nears.

Mid-Career

Again, debt remains a significant factor in how enjoyable your retirement years will be. So do everything you can to pay off your debts as you move closer to retirement. Paying off your credit card debt is a must. If you can afford it, you should pay off your mortgage, too. Not making monthly payments in your retirement years will prove a significant financial relief. The mid-point of your career is also the time to start drafting a financial plan for your retirement years. Discuss your goals for your post-work life with your spouse. For example, do you want to spend most of your time with your grandchildren? Do you want to travel the globe or take regular cruises? Maybe you want to take up golf. Your goals for your retirement years will impact how much money you will need for this time of your life. Armed with this information, you can sketch out a rough figure of how much you will need to save to reach your retirement goals. If you have not yet opened IRAs for you and your spouse, do so now. Be sure to contribute regularly to these accounts. Every bit of money you save now becomes critical as retirement nears.

5 to 10 Years Before Retirement

The Internet can help you determine if you are on track to have enough savings to support the lifestyle you desire during retirement. Use an online retirement calculator to determine how prepared you are for your retirement. That is also an excellent time to evaluate your savings vehicles. You should maintain a diverse portfolio, investing in bonds, stocks, and other savings vehicles. However, this is an excellent time to move more of your savings to lower-risk investments. That will protect these dollars as your retirement years draw near. It is essential to learn about Social Security during this time, too. You do not want to retire too early; this will diminish the amount of Social Security income you receive each year. In fact, the longer you can put off retiring — if you are healthy enough to work — the better financially off you will be. Not only will you draw more income to support your retirement years, but you will also boost the amount of Social Security benefits you receive each year. It is also best to practice living on your new income before finalizing your retirement. You might find that you have underestimated how much money you will need during your retirement years.

After Retiring

Once you have retired, you need to be cautious about how much money you withdraw from your retirement savings each year. Many retirees follow the 4 percent rule, meaning that they only withdraw 4 percent of their savings each year of retirement. That is a sound financial plan to take.

Retirement Planning Checklist

View Resource Retirement Planning Checklist
American workers who have retirement plans through their employers should take advantage of them. Without a solid retirement plan, security in retirement is uncertain. According to the U.S. Bureau of Labor Statistics, 69 percent of private industry workers have access to some form of retirement plan. While some retirement plans are better than others, that leaves a third of workers in the U.S. without access to an employer-sponsored retirement plan. That also means those workers will not have financial stability when they retire. Luckily, there are other options for retirement savings besides the traditional 401(k) and 403(b) accounts. For example, workers can still save for retirement using a payroll deduction IRA.

What is a Payroll Deduction IRA?

Payroll Deduction IRAs are individual (not employer-sponsored) retirement accounts. Typically, employees fund their IRA by having automatic deductions from their paycheck, hence the “payroll deduction” plan. In addition, employees can set a dollar or percentage amount that transfers to their retirement account from each paycheck. Workers can use a Payroll Deduction IRA to fund either a Traditional or Roth IRA. Similar to other individual retirement plans, the payroll deduction account may provide many low-cost investment options. In addition, payroll deduction IRAs are an excellent option for employers that can’t offer a traditional retirement plan. The payroll deduction IRA ensures employees can save for retirement.

How Do Payroll Deduction IRAs Work?

Typically, payroll deduction IRAs are set up with a financial institution. Once you determine which institution to use, you will pick either a traditional or Roth IRA. The main difference between the accounts focuses on when you pay your taxes for your contributions. Traditional IRA contributions are tax-free and only paid upon withdrawal. Meanwhile, Roth IRAs charge taxes on your contributions; however, you do not pay taxes upon withdrawal. Once you establish your account, you can set up your automatic payroll deduction. You can choose either a percentage of your paycheck or a set dollar amount. For example, if each of your paychecks is $5,000, you can have 10% deducted and sent to your IRA account. With this method, you will have $500 deducted each pay period and transferred directly to your IRA. Otherwise, you can choose a fixed-dollar amount to contribute every paycheck instead. Keep in mind that there are limits to how much you can contribute each year to an IRA. Your payroll deduction choices should consider these limits. You will quickly see the growth of your payroll deduction IRA account over time.

IRA Tax Benefits

IRAs come with certain tax benefits too.

Using Your Payroll Deduction IRA

Thankfully, simplicity and ease of use are attractive benefits of a payroll deduction IRA. You need to establish the account and set up your automatic payments so that you don’t have to worry about making contributions yourself. As you work and earn more money, you will see the overall growth of your account, which will eventually support you during retirement. In addition, payroll deductions do not require government filings like employer-sponsored plans. It is important to note that payroll deduction IRAs have the same contribution limits as other IRAs. In 2023, The maximum contribution limit for all IRAs for an individual under 50 is $6,500 and $7,500 for those over 50. Once you retire, your contributions from your payroll deduction IRA will be accessible so you can maintain your financial security well into retirement. However, employees who withdraw contributions before 59 1/2 will be subject to an income tax and 10% penalty.

Explaining Payroll Deduction IRAs

View Resource Explaining Payroll Deduction IRAs
For most people who have jobs in the U.S., Social Security contributions are automatic. It is not something you need to worry about because your employer takes care of it on your behalf. When you are self-employed, though, this is not the case. You alone are responsible for your taxes and your Social Security contributions. Here’s what that means for you.

Social Security for the Employed

People who work for a traditional employer have one significant tax benefit beyond essential record-keeping benefits. That is the fact that the employer and employee share the Social Security tax burden – each paying 6.2 percent on your earnings and each paying 1.45 percent of earnings as taxes into Medicare. These payroll taxes are taken out of your paycheck before you even have an opportunity to know they are gone. In many ways, that takes some of the sting out of paying these financial obligations paycheck after paycheck. In 2023, Social Security tax is assessed on the first $160,200 of income, while Medicare tax has no limit for income. Also, individuals who make more than $200,000 and married couples who make more than $250,000 will pay an additional 0.9 percent in Medicare taxes.

Social Security Responsibilities for the Self-Employed

On the other hand, self-employed people must shoulder this particular burden alone since you serve as both the employer and the employee in this arrangement, which means that you bear the full force of the Social Security and Medicare taxes. The current contribution you make is 12.4 percent and 2.9 percent, respectively. As with employer tax rates, you will only pay the Social Security tax on the first $160,200 of your earnings, while Medicare tax applies to your entire income for the year. The total tax burden for self-employed people earning $160,200 or less is 15.3 percent. While there are many legitimate business expenses you can deduct to reduce your overall income and Social Security tax liability, there is a great deal of debate over whether or not it is in your best interest to do so. Since Social Security is about ensuring some degree of financial security upon retirement, some feel paying the maximum possible amount now will serve you better upon retirement. Unfortunately, that means ignoring the expense deductions and paying the higher rate. However, that is not always the best way to go about it because Social Security bases the benefits on your income during the 35 working years in which you earned your highest income. That means that if you are making less being self-employed than in other parts of your career, you will want to minimize income. On the other hand, if you are earning on the higher side, you will want to report the higher income level and pay more in taxes now in return for more substantial benefits when you retire.

Business Expenses Impact on Amount Due

There are various expenses your business has that are allowed as deductions. That means you can subtract those costs from the income you would otherwise receive to reduce your self-employment tax obligations. One thing to remember is that 6.2 percent, or half of your social security taxes, are also deductible from your total income as a business expense. That means you subtract that amount from your taxable income and only pay taxes on the difference.

Report Earnings

If you are self-employed and earn $400 or more, you must report your earnings via the Schedule SE (Form 1040). That form will tell you if your earnings are subject to self-employment tax. However, most self-employed independent contractors or sole proprietors will use Schedule C or C-EZ forms. Social Security taxes can be pretty complicated. Therefore, it is a good idea to work with an accountant to determine your best long-term strategy for these payroll taxes.

Social Security and the Self-Employed

View Resource Social Security and the Self-Employed
Over the past several years, there has been a significant rise in gig workers and the number of affiliated companies that utilize them. According to MBO Partners, there are 64.6 million Americans who participate in the gig economy, which is roughly a 26% increase from the year prior. Being classified as a gig worker does not necessarily mean gigging was a person’s primary income source. Still, it could be substantial enough to report earnings. The gig economy workforce includes freelancers, self-employed consultants, contractors, on-call, temporary workers, and others in similar employment situations. Self-employment is an attractive career path for many individuals. Still, unfortunately, it does not come with a built-in retirement plan.

What Are My Options?

When you are a member of the gig economy, it is imperative you are proactive and set up your own retirement fund. As a gig worker, you typically have no other third-party or employer to rely on to set one up for you. However, taking control of your own retirement savings need not be frustrating or overwhelming. Here are a few options:

Dealing with Taxes

When you were a full-time employee, you were used to getting a W-2 form from your employer each year. Now, because you are a gig worker, freelancer, or sole-proprietor, you will receive a 1099-MISC form (most likely) unless you have made under $600. Depending on the type of freelancing you are doing, you might receive both a 1099 and W-2. You will also have to pay your estimated taxes each quarter too, or you could face late fees and a large bill at the end of the year when you file your tax return. You may be able to qualify for some type of monthly payment plan if you wind up owing more than you pay when tax season hits. You pay your taxes directly to the IRS as an independent contractor. Therefore you might be surprised by extra individual taxes. When you are employed, your employer covers half of your Medicare and Social Security taxes, or 7.65%, combined. However, when you are self-employed, you are responsible for paying the full 15.3% of Medicare and Social Security taxes.

What Insurance Do I Need?

If you do not have health insurance, this should be your first priority in the self-employment world. If you do not have health insurance, a severe medical condition or injury could require you to dip into your retirement savings. High medical bills also often lead to personal bankruptcy. If you cannot be on a spouse or parent’s plan or extend your COBRA coverage from a previous job, you will have to obtain your own health insurance. To do this, you can visit HealthCare.gov and choose from various plans in your area. You might also find a cost-effective health plan group via freelancers’ unions or professional organizations. Shop around to find the most affordable plan that will fit your needs. You could also open up a Health Savings Account (HSA). This will offer you a tax-advantaged way of saving for your health care costs. However, many individuals don’t realize HSA money can also be used for non-health-care expenses once you have hit the age of 65. And there would not be any withdrawal penalties on it either. However, for you to open an HSA, you will need a high-deductible health plan.

Takeaway

It can take some advance planning and creativity for a gig economy worker to reach retirement goals. Begin saving today to build your own nest egg using your tax refund. You can significantly impact your future with a little sacrifice now.

Gig Worker Retirement Strategies

View Resource Gig Worker Retirement Strategies
When you file for Social Security benefits or Supplemental Security Income (SSI), your lifetime earnings determine the amount of your monthly retirement benefit. However, this number is not static for the rest of your life. Your social security benefits will increase over time to keep pace with “inflation” or the cost of living. In other words, your retirement benefits will be affected by an annual process, referred to as the cost-of-living adjustment, or COLA. Congressional legislation authorized cost-of-living adjustments in 1973 and put it into practice in 1975. With these adjustments, SSI and Social Security benefits stay current with inflation to help retirees keep pace with their living expenses. Before 1975, only legislation led to changes for social security benefits.

Impact of COLA on Social Security Benefits

Cost-of-living adjustments are made based on measurements of inflation. When inflationary pressures are present, Social Security benefits adjustments get made in subsequent years. If there are no measurable changes, no COLA is applied. Because COLA depends on inflation, an increase does not occur every year. However, Social Security benefits will be increasing in 2023. Beginning with the December 31st, 2021 benefit, payable in January 2023, and continuing until the next COLA in October 2023, a COLA increase of 8.7 percent will be reflected in the SSI payments made to Social Security benefit recipients. As an example, if you received $1,586 in monthly Social Security benefits last year, and this year’s COLA is 8.7 percent, your monthly benefits for the coming year will be $1,724 ($1,586 x 1.087).

How COLA is Calculated

Cost-of-Living-Adjustments uses the Consumer Price Index (CPI), the official measurement of inflation used by the U.S government. The Consumer Price Index measures the prices of over 80,000 services and goods. Cost-of-living adjustments are made based on the CPI as specified by the Social Security Act. Specifically, Social Security adjustments use the CPI’s Urban Wage Earners and Clerical Workers (CPI-W) measurement. The Bureau of Labor Statistics calculates CPI-W’s monthly.

Issues with COLA Calculation Method

There are several concerns with how the Social Security Administration (SSA) estimates the average cost of living adjustments. First, the index the SSA uses only accounts for 32 percent of the total population’s spending habits, even though a newer index can evaluate 87 percent of people’s purchasing habits. In addition, the 32 percent represents a younger “wage earner” demographic, which is different than seniors or the elderly who receive social security benefits. Second, the CPI measurement used for determining Social Security benefits adjustments does not consider shifts in consumers’ spending habits when prices change. As an example, increases in the price of gasoline may transition consumers to use mass transit more regularly. The CPI does not reflect that spending shift. As a result, inflation’s impact might not be as meaningful, and it might not be needed to alter benefits. Third, some say the current method does not account for costs, such as out-of-pocket health care costs, that affect seniors the most. Therefore, they feel price indexes should be changed to more accurately measure senior spending. Congress has not instructed the Social Security Administration to derive a more accurate CPI to date. However, Congress can base COLAs on different measurement methods in the future. Since the Social Security Act may be nearing the point of needing a revamp, changing the way to calculate COLA is possible and could be part of any reform package.

How Cost of Living Adjustments are Calculated

View Resource How Cost of Living Adjustments are Calculated