Financial Face-Off: Is it better to be a W-2 payroll employee or self-employed? ‘You’ve got the ability to control your own destiny’

For a growing number, that means leaving their company job and striking out on their own as a self-employed freelancer or independent contractor. At the end of 2021, the number of workers who identified as self-employed (9.3 million) was up 8% from the beginning of 2020, according to the outplacement services firm Challenger Gray & Christmas.

So, what’s the better choice financially: to be a payroll employee or to be self-employed?

(By the way, “W-2” and “1099” in this column refer to tax forms. A payroll employee receives a W-2 form at the end of the year listing their wages and the taxes their employer withheld; a freelancer, independent contractor or small business owner typically receives a 1099 form listing payments they’ve received.) 

Why it matters

People are on the hunt for flexibility at work, and becoming self-employed can be one step toward achieving that goal. 

In addition to having more control over your schedule, being self-employed can deliver financial benefits. Companies often pay independent contractors higher wages than their W-2 counterparts. Self-employed people who work at home can qualify for the home-office tax deduction, meaning they can deduct certain expenses like rent/mortgage payments, utilities, and insurance. They can claim a mileage deduction if they drive for work, and they may qualify for a few other tax deductions related to being a business owner.

But when you’re self-employed, you’re responsible for the overhead costs that employers cover — costs that are easy to forget about when you’re a W-2er.

For example, you’ll have to withhold your own payroll taxes. You’ll also have to take care of the other benefits that employers provide. That means setting up your own retirement account and contributing to it, and — this is a biggie — paying for your own health insurance. You’ll also have to find and pay for your own disability insurance, and potentially, liability insurance. You’ll have to file self-employment taxes quarterly.

“Sure, 1099 employees get more flexibility. But I’m not sure it’s worth it,” said Shelly-Ann Eweka, senior director of financial planning strategy at TIAA. “It’s important to note that 1099 workers should negotiate a higher income to help cover all these additional costs — from benefits and taxes to retirement savings.”

Depending on what state they’re in, self-employed people may not have the same legal protections as employees, such as overtime pay and meal breaks. They don’t get paid vacation, parental leave or sick days.

Another lesser-known issue: Self-employed people can face hurdles when applying for a mortgage, says Rick J. Nott, a senior wealth advisor at LourdMurray in Los Angeles. “Mortgage rules are frankly, pretty old-school,” Nott wrote in an email to MarketWatch. “If you do not have a regular W-2 income, it can make the mortgage process very difficult and in some cases unattainable (even if the total gross pay is the same!)”

Another factor to consider is what stage of your career you’re in, Nott noted. “As an advisor, much of what I learned early in my career was from other people, in person, spontaneously,” Nott added. “Especially early in your career, there is something about facetime that might allow you to attract opportunities not available to someone who is remote. As the saying goes ‘Showing up is half the battle.’”

The verdict

W-2 payroll employee

My reasons

I’m generally risk-averse, so the potential financial benefits of being self-employed (like those tax deductions mentioned above) don’t outweigh the value of a regularly scheduled paycheck to me. The less income volatility you have, the easier it is to make a financial plan and set a path toward achieving goals.

It’s also possible that being our own boss could make it harder to set healthy boundaries between work and the rest of our lives (shout-out to fans of HBO’s “Severance”). A friend told me recently they were trying to “decouple” their self-worth from their job, and the comment made me think of this Financial Face-off. 

“Freelancing can be stressful and emotionally taxing for many people,” said Ben Henry-Moreland, a certified financial planner and founder of Freelance Financial Planning in Omaha, NE.

“The cliche that ‘when you do what you love, you don’t have to work a day in your life’ is turned on its head and becomes more like ‘when you do what you love, you are attached to that thing forever and can never stop.’ Unless you put in real boundaries between your work and non-work life, it can be very hard to feel like it’s OK to put the work down when getting paid depends on getting that project done.”

Is my verdict best for you? 

On the other hand, it’s worth pointing out that being a freelancer doesn’t necessarily mean living hand-to-mouth, says Henry-Moreland. “I think there is a notion that freelance income is inherently unstable or underpaid compared to W-2, which is not at all true,” Henry-Morleand said. “A lot of independent professionals do very well for themselves when they are able to find a valuable niche for themselves and communicate the value of what they do.”

Another myth to bust: the stereotype that you need to be “an extroverted, rise-and-grind #hustle type of person to pull off freelancing,” Henry-Moreland said. In reality, “many different personality types can thrive at self-employment.”

Jared Hoole, a CFP and president of Lakeside Financial Planning based in Burlington, Mass., says self-employment gives him the flexibility to be with his family. One big advantage that he sees: “You’ve got the ability to control your own destiny.” 

As a freelancer, you don’t have to contend with office politics or a manager that’s standing in the way of your advancement, he said. “I think everybody throughout their career has had at least one boss they didn’t care for, so not having to answer to somebody else is a big benefit in my opinion,” Hoole said.

Hoole made the switch from being a payroll employee thanks in part to his supportive wife, and he recommends it to others, with the big caveat that it helps a lot if your partner is a W-2 employee with steady paychecks who can add you to their health insurance plan. “To some extent the stars need to align,” Hoole said. “If you don’t have other people in your life who are supportive, it would be very hard to go out on your own.”

Another timely point is that the boom in remote work has nullified some of the reasons people may want to pursue self-employment, Henry-Moreland noted.

Many people think of being self-employed as a way to have more freedom to decide when, where, and how to work, he said. But, “as more companies have embraced remote work and flexible schedules, the difference between freelancing and traditional employment in this regard is a lot less today than it was just a few years ago, and a lot of people who would have needed to do freelance work to keep a nontraditional schedule have more options now.”

Tell us in the comments which option should win in this Financial Face-off. If you have ideas for future Financial Face-off columns, send me an email.