Money may be tight but that’s one of the best reasons to start saving now for retirement: it may not get better! Singers are doing it on a shoestring and here’s how.
Pension Plans
When your age dictates it’s time to retire your voice and you just don’t want to work anymore, will Social Security be enough to live on? Will it be enough to keep the lifestyle to which we have grown accustomed?
Most singers would answer “absolutely not!” Yet some of these same singers can’t seem to summon the self-discipline to save for retirement. Sure, performing artists are in a creative field and hope they never have to stop working. Some conductors are known to have waved the baton well into their 80s. But vocal faculties eventually fade. Arthritis may cause musicians to exit the workplace prematurely.
I could list other situations, but I’m sure you get the idea. Just as the squirrel stores nuts away for the winter, it’s prudent to store up funds for the winter of our years. The IRS has a variety of choices to encourage you to save for retirement, all of which come with some kind of tax advantage. Here’s a summary of the most popular plans and their features.
Most plans offer the up-front tax deduction on the money you put into them (the contribution). Let’s say you’re in a combined, marginal 30% tax bracket. For every $1,000 you’re allowed to contribute to the plan, your taxes will be reduced by $300. This is like getting an instant 30% return on your money! Another feature found in all plans is the deferment of tax on the investment’s earnings. This allows you to keep the entire earnings—dividends and interest or capital gains—reinvested in the plan. If you had to pay tax on the earnings each year, you’d have less in the investment, and that’d bring smaller yields. Although this feature has great merit, remember that the tax is eventually paid when the money is taken out (distributed) from the plan, except in the case of the ROTH IRA. This benefit comes by deferring taxes today, when you’re working and probably in a higher tax bracket, and then paying them later, when you’re retired and withdraw the money. Also, with some plans like IRAs (Individual Retirement Accounts), you can name a young beneficiary who can extend your retirement-plan distributions through to their lifetime expectancy. That keeps the deferring feature going and going: tax payments to the IRS can thereby be postponed for many years.
You should realize that when you work, sometimes you’re considered an employee and sometimes a self-employed person. Employees’ earned income is shown on the W-2 for, with tax withheld. Self-employed people get the 1099 form, usually with no tax withheld. Your eligible earned income—or income from working, as opposed to such other income as interest or capital gains—is your gross W2 but your net (gross after expenses) Schedule C. This distinction is important because the limits of pension plans key off of these amounts. What follows are some of the rules for pension plans for the tax year 2002.
For the do-it-yourself folks, check with your favorite bank or discount brokerage. For folks who aren’t do-it-yourselfers, find a good investment advisor.
Traditional IRA. It’s available up to your earned income but with a yearly contribution limit of $3,000, or $3,500 if you’re age 50 or older by Dec. 31, 2002. If you have any other pension plan, the IRA is only deductible on your tax return if your adjusted gross income (AGI) is less than a prescribed limit. Check the IRS instructions because this limit changes each year and depends on your filing status.
Advantages: Tax deduction now and deferred tax on growth of investment. This is also a good way to leave a legacy to beneficiaries, since arrangements can be made for the assets to be distributed over their lifetimes.
Disadvantages: Taxed at regular rates, as opposed to lower capital-gain rates, and penalties if money is distributed, or withdrawn, before age 59. Also, you must start a minimum distribution of IRA value by age 70. And you can’t contribute for the year you turn 70 or any year after that. It must be set up by April 15, 2003, if you wish to put money into it for the tax year 2002.
Roth IRA. It’s available up to your earned income with a yearly contribution limit of $3,000, or $3,500 if you’re age 50 or older by Dec. 31, 2002. To use the Roth IRA, it doesn’t matter if you have another pension. Your AGI must be under $95,000 if you’re single or $150,000 if you’re married.
Advantages: Deferred tax on growth of investment and tax-free withdrawals of principal. There can be tax-free withdrawals on growth too if you’re over 59 and kept the principal in the Roth IRA for at least 5 years. Contributions are allowed after you turn 70.
Disadvantages: No up-front tax deduction. The Roth is generally a better choice than the traditional IRA if you’re under 50, allowing many years of potential tax-free growth before you may need it. It must be set up by April 15, 2003, if you wish to contribute to it for the tax year 2002. Also, check into converting your traditional IRA to a Roth IRA. You’ll have taxes to pay today, but the rewards can be big as your assets can grow over time, tax free. When it comes to paying taxes, zero is a great number!
SEP IRA. The SEP, or “simplified employee pension,” is based on net self employment, generally up to 20% of net Schedule C. (It’s really limited to 25%, but since the math requires you to deduct the SEP itself, it comes to 20%). The contribution limit is $40,000 for the tax year 2002. The SEP must be set up by the due date of your tax return, including extensions, which can extend the due date all the way to Oct. 15, 2003. You can use the SEP IRA even if you have another pension plan. A SEP is similar to a “Profit Sharing Plan,” except that with Profit Sharing, you must file Form 5500 when the asset value exceeds $100,000. That’s a nuisance, but the off-setting benefit to the Profit Sharing Plan is that you can have borrowing privileges up to $50,000.
Advantages: Tax deduction now and deferred tax on growth of investment. Disadvantages: Taxed at regular rates, as opposed to lower capital gain rates, and penalties if the principal is distributed, or withdrawn, before age 59. Also, one must start a minimum distribution of asset value by age 70.
401(k). It can be based on 100% of net self employment. Limits: $11,000, or $12,000 if you’re age 50 or older by Dec. 31, 2002. To use a 401(k), it doesn’t matter if you have another pension plan. So, if a 401(k) is combined with a SEP or a Profit Sharing Plan, the limit is $40,000, or $41,000 if you’re 50 years old or older. For example, if your net Schedule C is only $11,000, you can put $11,000 into a 401(k), thereby off-setting your income by 100%. If it’s $150,106 or more, you can put the $11,000 into the 401(k) and $29,000 into a SEP, giving you a total of $40,000, which is the maximum for those plans, except for the extra $1,000 if you’re 50 or older.
Advantages: Tax deduction now and deferred tax on growth of investment. Disadvantages: Taxed at regular rates, as opposed to lower capital gain rates, and penalties if taken out before age 59. Also, you must start a minimum distribution of asset value by age 70. You must set up your 401(k) by the due date of your tax return, including extensions, which can extend the due date all the way up to Oct. 15, 2003. But if you wish to contribute for 2002, the 401(k) must be established by Dec. 31, 2002.
There is great portability of retirement assets. You can now move assets between plans fairly easily. For example, traditional IRA can be rolled over, or transferred, into your SEP or 401(k) and visa versa. This means that you don’t have to keep an old plan to which you’re no longer contributing. Many brokerages charge fees to administer pension plans and by combining assets, you can reduce these annual charges.
With all of the advantages shown above, you simply must start a planning strategy to save something for retirement. There’s no time like now to get started.
