No 401(k)? No Problem!

I know what you’re thinking, “You’ve got to be joking.  Retire? ME?”  You may feel like a retirement plan is a total non-sequitur for you as an independent music teacher.  Maybe you’re pretty sure that the only retirement plan you can afford is to have your kids take care of you when you’re old.

I’m here to tell you it doesn’t have to be that way. YES, even independent music teachers who don’t work for a school district and won’t get PERA benefits can plan for their retirement.  I am not a financial advisor, and you should consult a professional before investing.  And if you keep reading, you’ll get some free good advice from a REAL professional financial advisor!

Here are two great, tax-favored retirement account options that you can take advantage of as an private music instructor/business owner:

SEP IRA

SEP IRA is a type of traditional IRA for self-employed individuals or small business owners. (SEP stands for Simplified Employee Pension.) Any business owner with one or more employees, or anyone with freelance income, can open a SEP IRA.  There are two really cool things about SEP IRAs.

  1. They are tax-deferred.  This means anything you contribute this year does not count as taxable income for this year.  You will pay the income tax when you withdraw the money at age 59 ½, and here’s why that matters:  You are paying self-employment taxes right now! Your tax rate is probably on the order of 36% because you are paying all your own FICA and Social Security taxes!  Save that money for a year when you DON’T have to pay self-employment taxes on it!  (N.B. Talk to your CPA about how much of your net profit to save out for taxes.  My accountant’s advice was 36%)
  2. You can put up to 25% of your annual net profit into a SEP IRA for each eligible employee up to $52,000 (2014 limit). If you’re a sole proprietor, this means only you; but if you have employees it means them too.  This is a truly ridiculous percentage of your income that you’re allowed to defer taxes on, and you don’t want to pass it up!

Think about it this way: Let’s say two music teachers each earned $100.  One of them has no SEP IRA account.  The other one does! Here’s how it plays out:

No SEP IRA Contribution

Net Profit Earned: $100

Taxable income: $100

Taxes (36%): $36

Net income after taxes: $64

Yes SEP IRA Contribution

Net Profit Earned: $100

SEP IRA Contribution: $20

Taxable income: $80

Taxes(36%): $29

Net Income after taxes: $51

 

Yes folks, that’s right. It only costs you $13 to put $20 into a retirement account.  Another way too look at it is that you save roughly $7 on taxes for every $100 you earn if you’re putting in 20% of your profits. That’s like free money from the government. If you haven’t started your SEP IRA yet, do it this month!

One thing to note – If you have employees, you are required to contribute the same percentage to each of THEIR SEP IRAs as you do to your own, so once you start hiring people your approach to this retirement tool may change.  However, if your goal is to grow a large music conservatory-type studio with a few committed employees, this could be a great profit sharing tool!

Roth IRA

The old saying goes, nothing is sure but death and taxes.  In the case of a Roth IRA, it’s only partly true! A Roth IRA is an individual retirement account allowing a person to set aside after-tax income up to a specified amount each year. Both earnings on the account and withdrawals after age 59½ are tax-free. This means it is tax protected on the back end. The amount you can contribute changes from year to year, so consult your financial advisor about this year’s limit.  In 2014, the limit is $5500 per person.

Generally speaking, you’ve got to pay taxes on any money you earn once, and there’s no way around it.  But in the case of a Roth IRA, you NEVER have to pay taxes on the growth!  This means that if you invest $100 (which you’ve already paid taxes on), and it grows to $200 over the course of 15 years, you can withdraw the entire amount without owing any more taxes on it!  In most other kinds of IRAs, you will pay taxes on the growth of anything you withdraw, but not here!

Roth IRAs do not reduce your taxable income right now, but they do reduce your taxes in the future. And, considering that taxes are currently at virtually an all-time low, I think we can bet on taxes being higher in the future (self-employment tax notwithstanding).



Advice from a Real-Life Professional Financial Advisor:

Suzanne Abrams is my Financial Advisor, and if you’d like to contact her, I’ve added her information below!

“Music teachers will understand consistency of practice as one of the most important factors in mastering an instrument.  With investing for retirement, we should place the same importance on diligently “paying yourself first”.  Get into good habits with your money.  Budget a monthly contribution to your savings and investments and make it a priority.  Time is your greatest ally, so get started now – not tomorrow!  Even if you can only put $50 a month into your SEP or Roth, it will add up over time!  Once you get accustomed to that small amount, it’s not hard to increase it year by year.

Ask your CPA or accountant to calculate how much you’ll save on taxes if you contribute the max to your SEP IRA.  If he or she doesn’t tell you about the SEP, then you need to bring it up!  You can keep that tax savings and sock it away for the future.

Another benefit to budgeting a fixed amount each month can be attributed to an important concept called “Dollar Cost Averaging”.  Essentially, if you stick to a consistent amount every month, you’ll be able to buy more shares when stocks are priced low and fewer shares when shares are priced high.  Over a long period of time, that means you’re disciplined to buy more shares at low cost and less shares at high cost.  You know the old adage, “Buy Low, Sell High”?  Dollar Cost Averaging into the market allows you to take the emotion out of when to buy.  If markets are in a state of despair, you’re still buying in when shares are at rock bottom prices and that’s a very good thing!

Just like you aspire to have a daily practice, you should stick to an automatic investment plan.  Consistency and practice make all the difference in a long term plan to improve your playing as well as your retirement nest egg.”

Suzanne Abrams, Lundeen-Abrams Advisors

952-933-8489 or suzanne@lundeenabrams.com

A lot of Financial Advisors (including Suzanne) will give you this advice:  Max out your SEP first, and THEN put whatever else you can into your Roth. This is pretty good advice, in my opinion.  Do what you can to reduce your tax burden now, and then do whatever else you can to reduce your tax burden in the future.  What is the biggest obstacle keeping you from starting your own retirement account(s)? What would it take to make you get started tomorrow?

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