FREELANCERS: RETIREMENT SAVINGS 101
Hey, how often do you think about being an old person? As someone with a deep, persistent fear of dying alone and penniless, I think about this a lot. I can solve the āaloneā part with a lot of cats, but the āpennilessā part is a little trickier. I canāt count on the fact that Iāll be able to work forever, and as a freelancer I donāt have a pension or an employerās 401k plan to sustain me. Iām CERTAINLY not counting on Social Security to bail me out, and neither should you.
This is where Individual Retirement Savings (IRAs) come in! I havenāt seen much advice about this geared towards artists, so I thought Iād write a post about it. You can start saving at any age for your future comfort and happiness, and thereās no blood sacrifice or mystic knowledge required! What is required is a basic understanding of how IRAs work, and the willingness to sign up for one and start saving. If you are earning money, donāt have a retirement savings account, and can spare a chunk of cash each year, start now!
There are few different kinds of IRA, but for simplicityās sake Iām mostly focusing on Traditional IRAs and Roth IRAs. Each IRA has the same goal, to allow you to save money for retirement, and to let your money to grow tax-free in the time in-between. You can set one up for yourself so long as you (or your spouse) have earned income.
What makes IRAs different from a regular savings account? IRAs can generate a lot more earnings over time because you donāt pay taxes every year!
IRAs are typically composed of investments (in mutual funds, stocks, bonds, etc.) so your gains will fluctuate year to year depending on the financial landscape and the kind of investments madeābut you can expect to earn around 7% over the long-run, which is way better than the average savings account interest rate of 0.06%. Thatās not to say that a savings account is bad. If you have a savings account, THATāS GREAT. If you have extra savings and youāre willing to wait 30 or so years to take it out, open an IRA to take advantage of the higher growth potential!
You can open an IRA through most large financial institutionsābanks, mutual fund companies, and brokerage firms, any of which can offer a variety of investment options. The fees and fee structure for each institution can vary however, so itās good to compare. (You can start by searching on google for āwhere to open a Roth IRAā or āwhere to open a Traditional IRAā)
TRADITIONAL & ROTH IRA, COMPARE & CONTRAST
Who can contribute to an IRA?
In a Traditional IRA, anyone with earned income of any amount can contribute, but you must be younger than 70 Ā½. In a Roth IRA, you can be any age, but you must have a modified adjusted gross income of less than $131,000 if youāre single, or a modified adjusted gross income of less than $193,000 if youāre married filing jointly.
How much can you contribute per year?
In both plans, you can contribute up to $5,500 each year, or up to $6,500 if youāre age 50 or older. You donāt have to contribute the max amount, and you donāt have to contribute every year. The max amount is increased every so often so itās a good idea to check into the current maximum contributions allowed (just google āmaximum IRA contributionā)
Whatās the deal with taxes??
The big difference between Traditional IRAs and Roth IRAs is when your money gets taxed. With a Traditional IRA, when you CONTRIBUTE money you donāt have to pay taxes on it, but when you WITHDRAW money you have to pay income tax on it at that time.
In a Roth IRA itās the oppositeāwhen you CONTRIBUTE your money you pay taxes on it, and when you WITHDRAW the money it is entirely tax-free.
Simplistically, this means that if you are currently in a high tax bracket and think you will be in a lower tax bracket by the time you retire, a Traditional IRA may save you more money. If you are in a low tax bracket right now and anticipate that by the time you retire your income taxes will be higher, the Roth IRA will be a better fit. You can also have retirement savings in both kinds of accounts (though your total contribution per year still maxes out at $5,500/$6,500), and/or roll over one kind of account into another down the line.
One big tax caveat: If you or your spouse have the ability to contribute to an employer sponsored retirement plan (i.e. 401k) you can still contribute to a Traditional IRA, but you will NOT get the tax deduction. This is referred to as a ānon-deductible IRA contributionā, and it affects āpre-taxā IRA accounts, like Traditional IRAs. Employer sponsored retirement plans have no effect on your contributions to a Roth IRA account though!!
Thereās a 10% penalty if you withdraw money from your IRA account at the wrong time. So WHEN can you withdraw your money without penalty?
In a Traditional IRA, you can start withdrawing your money at the age of 59 Ā½, and MUST start taking minimum withdrawals at age 70 Ā½. (I donāt know why the half-numbers are important, but themās the facts!)
In a Roth IRA, there are no mandatory withdrawals, and you can start withdrawing your money at the age of 59 Ā½ ā if your withdrawal is at least 5 years after your first contribution was made. (So, if you start contributing to a Roth IRA at age 56, you wouldnāt be able to withdraw your earnings without a penalty before the age of 61. This isnāt an issue if you start earlier!)
Roth IRA BONUS: Roths allow you to withdraw your previous contributions at ANY TIME without penalty, provided you donāt take out the interest your contributions earned. (So if you contribute $10,000 over time and your Roth IRA earns an additional $8,000 in interest for a total of $18,000 in your account, you can still withdraw that original $10,000 at any time, no matter when or what age you are)
SO WHAT DOES THIS MEAN FOR YOU??
It means that young freelancers are in an ideal situation to start contributing to a Roth IRA account. If you are just starting working, itās likely that you are in a lower tax bracket right now than you will be later, so Roth IRAs can be very beneficial. The longer you have your money in a retirement savings account, the more time it has to growā$5,500 a year may sound like a lot to contribute at first, but you donāt have to contribute the full amount and you donāt have to contribute every year. If you can only contribute $1,000 a year, contributing ANYTHING is better than nothing, as long as you start sooner rather than later. Also, because Roth accounts let you withdraw your original contributions at any time, if you find you need to use some of that money for an unexpected expense you can always take it out without penalty.
ONE !!!IMPORTANT!!! CONSIDERATION:
There is MONETARY RISK involved in contributing to any IRA. Since all IRAs are investments and investments can fluctuate, there may be some years where your account experiences losses instead of gains. Sometimes there may be less money in the account than what you contributed. This is to be expected, and the longer you are able to let your account grow the greater your overall gain will be, despite any fluctuations along the road. This is another reason why starting as soon as possible is best.
Other situations to consider:
If you already have a 401k account from an employer, you can also open your own IRA in addition. If your employer matches your 401k contributions, do that firstāthatās free money! If you max out your employer contributions and want to contribute more, you can put the rest in your own IRA (but it will be considered a ānon-deductible/after-tax contributionā. See āOne big tax caveatā above)
If you are self-employed (or a small business owner) and you would like to contribute more than $5,500 each year to an IRA, consider the SEP IRA. The SEP IRA functions very similarly to a Traditional IRA, but you can make higher yearly contributionsāup to $53,000 per year! There are other rules that govern this, though.
Artists, if your cost of living can support it, start a retirement savings account now if you donāt have one already. Itās the best thing you can do for your future-self.
Full disclosure: Iām an artist, not a āwealth management professionalā and if you have any questions about retirement savings accounts you should talk to qualified persons. Iām just scratching the surface hereāI speak only from my own experience & simplified understanding. Iām happy to have a Roth IRA account with Morgan Stanley/Smith Barney and have been contributing since college, my uncle works there and is my financial adviser. I wrote this because I have seen very little income-allocation advice geared towards artists, and I feel fortunate to have benefited from my parentsā and uncleās experience. Contributing a little bit to your future security is easier than you may think.
