Retirement Plans (self-employed)

[JLivi]

Based on the "Business Advice" thread, I was curious what other folks were doing in regards to retirement plans. I didn't want to completely clog that thread with this topic.

As of right now I just have an IRA that gives me the tax benefit (traditional). I've had some advice from other musicians, my financial guy, and my dad (CPA) on some of the following:

- IRA (roth or traditional)
- SEP IRA (25% of self-employed income can go into this)
- Brokerage account (if the IRA Max ($6k) is met start saving for this account to start investing)
- Self-Employed 401k (i think if you have "employees" you can't sign up for this)
- permanent life insurance (whole term)
- Money under the mattress

Just curious to see what others are doing. Obviously you don't have to give a ton of details because this can be and should be a private matter, but it's always nice to know what people are doing in regards to their financial future. I wish someone older than me sat me down and told me about IRA's when I was in my early 20's.

I heard a quote this weekend that "if your friends don't talk about money you need new friends." I think someone famous said it, but I could be wrong

[hyperbolica]

I would say the first bit of advice is to keep your debt low (debt to invest in real estate is good because real estate usually gains value over time, "investing" in a new car is not good because of the rate at which the new car loses value - investing in a 1963 Corvette could be a good thing if it gains value and you don't wreck it).

Then keep enough money available for whatever kind of emergency you might feel the need to plan for. This should be accessible within a day, so probably a savings account.

Then start with an IRA. Once you max out the contribution to the IRA, you have to look at the other options to minimize taxes.

[JLivi]

I would say the first bit of advice is to keep your debt low (debt to invest in real estate is good because real estate usually gains value over time, "investing" in a new car is not good because of the rate at which the new car loses value - investing in a 1963 Corvette could be a good thing if it gains value and you don't wreck it).

Then keep enough money available for whatever kind of emergency you might feel the need to plan for. This should be accessible within a day, so probably a savings account.

Then start with an IRA. Once you max out the contribution to the IRA, you have to look at the other options to minimize taxes.

I agree with all of this, but shouldn't you start with an IRA? Or at least have retirement savings included in your savings towards a down payment on real estate?

I started my IRA at 27 and wish I started earlier. I try to tell everyone I know who's under 25 to at least start it and get money in the account. Even if it's $20/month. If they can do $100/mo great! Try and build to $500/mo (IRA max).

The later you start saving for retirement the bigger disadvantage you're at because of how compound interest works. I alway go back to this scenario. In a nutshell, you can save $2k/year from 19-27 and have more money at 65, then if you save $2k/year from 27-65.
https://www.daveramsey.com/blog/how-tee ... llionaires

[harrisonreed]

In the US, I would do a Roth IRA if at all possible. Especially if anyone is making a living as any type of non-celebrity musician, I doubt their financial situation is so bright that a traditional IRA would be advantageous over a Roth. If you are keeping your Roth with a low cost form like Vanguard, using their ultra low cost ETFs, You would statistically do great in the long run and have a really large capital gain (percentage wise -- but if you put only pennies in, it doesn't matter if you return 8% each year for 30 years). Who wants to pay tax on that? Especially when a working musician is likely to be in the lowest income bracket. So there's a change I would make.

If your investments aren't Vanguard ETFs (eg, VOO's expense ratio is like .05%), which trade for FREE in their brokerage accts, you're likely losing out on money over time. Especially if you aren't investing gobs (ie "corporate levels") of money.

[hyperbolica]

I agree with all of this, but shouldn't you start with an IRA? Or at least have retirement savings included in your savings towards a down payment on real estate?

I look at it this way. What saves/costs you the most?

Credit card debt is very expensive, and that rate over time is murderous. So I'd pay that off absolutely first, and do what I can to avoid it in the future, even taking out savings, because savings only gains you 5% or less, and credit cards are much higher. So keeping savings while you have cc debt is a losing proposition.

A house can be a medium term gain, and the gains can be significant, depending on a lot of things. Plus, it turns what would normally be a straight expense (rent) into a tax deduction (mortgage interest). IRA is a good habit, and that's one reason to start it early, and there's the tax reason to do it, so yes, this is a good idea as long as you're paying taxes and you can afford to stay out of other debt. Now, if it's a 401k and your employer is contributing, you can double down on it as hard as you can, because that doubles your money. But I would still prioritize a mortgage over IRA, because of the combined investment, tax, and basic needs that a mortgage provides. Rent only provides basic needs. IRA is only about taxes and the investment.

Of course a lot of this goes out the window as of a couple of years ago, when fewer of us need to itemize.

[JLivi]

In the US, I would do a Roth IRA if at all possible. Especially if anyone is making a living as any type of non-celebrity musician, I doubt their financial situation is so bright that a traditional IRA would be advantageous over a Roth.

Roth would be good for single musicians, who aren't rock star celebrities

Personally, I'm in a traditional IRA because I'm married and in a higher tax bracket due to the combined income. I'm also 20-30 years away from retirement. Who knows what tax laws will be in effect by then. So for right now we're taking the tax benefit.

I look at it this way. What saves/costs you the most?

Credit card debt is very expensive, and that rate over time is murderous. So I'd pay that off absolutely first, and do what I can to avoid it in the future, even taking out savings, because savings only gains you 5% or less, and credit cards are much higher. So keeping savings while you have cc debt is a losing proposition.

A house can be a medium term gain, and the gains can be significant, depending on a lot of things. Plus, it turns what would normally be a straight expense (rent) into a tax deduction (mortgage interest). IRA is a good habit, and that's one reason to start it early, and there's the tax reason to do it, so yes, this is a good idea as long as you're paying taxes and you can afford to stay out of other debt. Now, if it's a 401k and your employer is contributing, you can double down on it as hard as you can, because that doubles your money. But I would still prioritize a mortgage over IRA, because of the combined investment, tax, and basic needs that a mortgage provides. Rent only provides basic needs. IRA is only about taxes and the investment.

Of course a lot of this goes out the window as of a couple of years ago, when fewer of us need to itemize.

This is great advice! I'm glad we have a conversation going. I probably should've been more clear in my original post of assuming you have no credit card debt. That is a killer!

[dougm]

I would only do Roth IRAs if you can. Some folks feel they need the tax savings of a traditional IRA, but long term the Roth is much better.

Whole life insurance is a terrible investment, a terrible product, and something I would avoid. If you need life insurance, shop term insurance. If you want to invest, invest.

Doug

[krahnbone]

I have a Roth IRA and that's it. Wish I started it sooner, but such is life...

Looking to buy real estate instead of renting; that'll be the big move to stop treading water. However, even when I have the down payment together, proving my income to lenders is a tough sell.

The question on my mind is, with coronavirus scares and all, is now a good time or a great time to invest?

[harrisonreed]

Roth would be good for single musicians, who aren't rock star celebrities

Personally, I'm in a traditional IRA because I'm married and in a higher tax bracket due to the combined income. I'm also 20-30 years away from retirement. Who knows what tax laws will be in effect by then. So for right now we're taking the tax benefit.

Hmmmm...

20 to 30 years of compounded gains in the market could add up to a really huge gain. Let's say...:

1. You are doing reasonably ok. So you can contribute about $2500 a year to your IRA. Maybe you've already got 30k in there.

2. You can conservatively hope for an 8% average annual gain. This is less than the historical average, but who knows?

3. In 30 years, you'll have $607,000 in your IRA, but you only contributed about $100k of that. The remaining $500k is all gain.

I am wracking my brain to think of a situation where someone can offset their annual income enough with a measly IRA contribution (even the $6000 max) to make the tax savings of being in a slightly lower tax bracket offset and beat having to pay taxes on $500,000 of capital gains in their retirement account as they withdraw the money. And if you're reducing your income by $6000 (the full contribution) each year, your IRA will be above $1,000,000 with the conditions above.

With two people, under the best circumstances you're reducing your income by $12,000. The more you make, the less impact that has on your tax bracket. They say that it makes sense for the super rich to use traditional IRAs (if they make more than 200k, that's the only option), but I'm imagining a family with an income of $180,000. A $12,000 dent in that income probably won't shift the tax bracket at all. Someone with some investing know how or stock options in that situation would be a fool to not use the Roth because they probably have even more opportunity for a massive capital gain.

Speaking of stock options -- and this is now off topic -- there are lots of people making sizeable income who can put stock options from their job into a Roth IRA or Roth 401K, and they are getting these for pennies on the dollar (pre IPO, etc). Take Facebook for example. Pre IPO, some employees could put $5500 of FB stock into their Roth at $5 a share, or whatever the made up value was -- it could have been $.05 for all I know. Maybe they got to do that for a few years. FB is now publicly traded and those shares are around $200 each. You do the math. They won't pay a dime on the gains, and FB is still a very young company.

[JLivi]

I am wracking my brain to think of a situation where someone can offset their annual income enough with a measly IRA contribution (even the $6000 max) to make the tax savings of being in a slightly lower tax bracket offset and beat having to pay taxes on $500,000 of capital gains in their retirement account as they withdraw the money. And if you're reducing your income by $6000 (the full contribution) each year, your IRA will be above $1,000,000 with the conditions above.

With two people, under the best circumstances you're reducing your income by $12,000. The more you make, the less impact that has on your tax bracket. They say that it makes sense for the super rich to use traditional IRAs (if they make more than 200k, that's the only option), but I'm imagining a family with an income of $180,000. A $12,000 dent in that income probably won't shift the tax bracket at all. Someone with some investing know how or stock options in that situation would be a fool to not use the Roth because they probably have even more opportunity for a massive capital gain.

I suppose my thought was that I don't plan to pull the exact amount of my annual income in retirement. In your example, 180k household income, that would put you in the 24% tax bracket today. Now I heard from my financial advisor that generally you only need 65% of your annual household income to survive in retirement, which would be 117k needed to live the same lifestyle. That alone would drop you down to the 22% tax bracket.

2% difference in tax is somewhat negligible, but what if you or your spouse had a pension? Or you opened a brokerage account and made some extra money and didn't need to pull the full 117k out of your IRA. If you somehow found 39k in pension money or other retirement accounts, then you'd fall in the 12% tax bracket. Now you're cooking with gas! 24% vs 12% is a BIG difference.

I guess this is my defense for having a Traditional instead of a Roth. But the good thing is that my wife has an odd 401k that splits between two IRAs, so she's diversifying her investments.

I could have this all wrong, but I'm glad a conversation is happening. This is all great, and making me think.

---side question---
When you roll your IRA into a brokerage account after retirement, do you pay taxes on the lump sum then, or when you withdraw from the account? I'm assuming when you withdraw from the brokerage account. I'm not really sure how that works.

[Dennis]

I am wracking my brain to think of a situation where someone can offset their annual income enough with a measly IRA contribution (even the $6000 max) to make the tax savings of being in a slightly lower tax bracket offset and beat having to pay taxes on $500,000 of capital gains in their retirement account as they withdraw the money. And if you're reducing your income by $6000 (the full contribution) each year, your IRA will be above $1,000,000 with the conditions above.

FWIW, you don't pay capital gains taxes on IRA distributions. It's taxed as ordinary income at the rate applicable to your situation in retirement.

With respect to Roth IRA vs IRA/401(k)/403(b), here are the factors as I see them:

• IRA/401(k)/403(b) contributions carry a tax benefit now (they reduce your taxable income today).
  
  Roth IRA contributions are made from taxable income today. They carry a tax benefit later (under current law the withdrawals are not taxable income then.)

In both plans, the accrued earnings are untaxed. For me, the choice comes down to this: how much do you trust the government to leave the Roth IRA deal in place? I don't trust them, and so I'll take my piece of pie today (and reduce my current taxable income). After I've maxed out my IRA contribution, I contribute to my Roth.

If your employer offers an retirement plan (IRA, 401(k), 403(b), or defined benefit pension plan) where they match your contributions, you should always contribute at least the amount required for the maximum employer match. That is the easiest money with the least risk you'll ever encounter.

Some of my friends and colleagues have a different risk/benefit evaluation than I have. They contribute enough to their employment retirement to pick up all of the employer's contribution and put everything else into Roths.

The important thing is to have a retirement plan and to make regular contributions to it.

The tax law changes changed things about retirements plans. You no longer have to take minimum required distributions at age 70.5: mandatory minimum distributions do not begin now until age 72 or when you stop making contributions, whichever is later. Another change allows you to continue contributions past age 70.5. If you leave the retirement account to someone, there are also changes, but those are the heirs problem rather than yours. (P.S. If you are planning to use retirement accounts to provide for a disabled family member, see a financial advisor real soon now to make certain things are still in order after the tax law changes.)

[Dennis]

I guess this is my defense for having a Traditional instead of a Roth. But the good thing is that my wife has an odd 401k that splits between two IRAs, so she's diversifying her investments.

I could have this all wrong, but I'm glad a conversation is happening. This is all great, and making me think.

---side question---
When you roll your IRA into a brokerage account after retirement, do you pay taxes on the lump sum then, or when you withdraw from the account? I'm assuming when you withdraw from the brokerage account. I'm not really sure how that works.

Having two IRAs isn't necessarily diversifying your investments. You have to look at how the funds are investing.

For example, I have a roll-over IRA brokerage account and a SIMPLE IRA account through my employment. They are investing in different mutual funds, but I don't count this as diversification because the types of investments and fund objectives are very similar.

If you close out an IRA and put the money into an ordinary (taxable) brokerage account, the full amount of the withdrawal will count as taxable income in the year you close the account. If you roll the IRA over into a rollover IRA account, you will only be taxed on the amounts distributed from the (rollover) IRA.

[JLivi]

Having two IRAs isn't necessarily diversifying your investments. You have to look at how the funds are investing.

For example, I have a roll-over IRA brokerage account and a SIMPLE IRA account through my employment. They are investing in different mutual funds, but I don't count this as diversification because the types of investments and fund objectives are very similar.

If you close out an IRA and put the money into an ordinary (taxable) brokerage account, the full amount of the withdrawal will count as taxable income in the year you close the account. If you roll the IRA over into a rollover IRA account, you will only be taxed on the amounts distributed from the (rollover) IRA.

Sorry for my confusion. I didn't mean diversifying investments. Diversifying over Traditional vs. Roth. That way it's a win/win or lose/lose, it depends if you see the glass as half empty or half full

But we are trying to hedge our bets, I suppose