Archive for Retirement Planning

Financial planning for a freelance or self-employed income

It’s easy to divvy up a paycheck. Freelance income, not so much. The biggest problem with making a spending plan (because we all hate the word budget, right?) is that you’re never sure how much you’re going to get, and when it’s going to show up. This is a huge problem when you’re first starting out, but it’s still an issue even after your established—while you might know your average earnings, you still don’t know exactly when the check will be in the mail.

I’ve long recommended Ramit Sethi’s concept of dividing your income into percentages, rather than amounts. This works whether you get a regular paycheck or intermittent checks from freelancing or a small business. When I work with clients, we focus on constraining fixed expenses, prioritizing different types of savings, and managing discretionary spending. But if you’re a one-or-few person operation, there’s more to consider. I’ve been very happy, recently, to discover Mike Michalowicz’s book Profit First. (Disclaimer: both of these gentlemen sell a lot of products and services. I’d suggest reading their books and being an aware consumer–figure out what’s right for you!)

How much do you need to keep the business running? As a solo, it’s very easy to send nearly all the money to your personal account, then need to loan it back when business bills come in. Even if you don’t have a lot of expensive memberships and licensing requirements (my hand’s up), you’re still going to need to replace computer equipment; update software; print business cards, brochures, etc.; and perhaps pay an accountant or attorney. To this I would add that if you’re truly self-employed, you’re also going to need to factor in the cost of benefits usually supplied by an employer: health, life, and disability insurance; a reasonable amount of paid vacation, sick days, and holidays; contributions to a retirement plan; and the space you need to work. Michalowicz suggests that these operating expenses should be no more than 30%. I might quibble with that a little if we include health insurance, and I’ve been hard pressed to keep them under 35% myself, but it’s a good general principle.

The next big bugbear after keeping the doors open is keeping the wolf (aka, the IRS) away from them. Rather than scrambling to come up with the quarterly payment two days before the end of each quarter, Michalowicz suggests putting 15% of every check in a (preferably inconveniently located) savings account. This actually seems a little high to me, particularly for a start-up where you may not have all that much taxable income, but it depends on how the business is organized, and what you’ve paid in the past. In any case, I’d suggest no less than 10% of each payment/check go to tax savings. If you don’t need it all, there’s always next year (or property taxes).

When do you pay yourself? Okay—next up, owner’s pay. Here, Michalowicz suggests you pay yourself 50% of the gross. This is the amount that I would consider available to apply Sethi’s budget percentages, although where the retirement savings comes from depends on your own business model—just be sure it comes from somewhere!

Finally, Michalowicz points out that it’s absolutely essential to set aside something—5% suggested—for profit. As he rightly points out, without siphoning off some amount, you’ll have nothing to show for your work. Although he suggests using this money to ultimately reward yourself for hard work, I’d be conservative and say this is your business emergency fund until you have enough to keep up with expenses for 3-6 months, tiding you over any cash flow crises or dry spells.

Try out the percentage system. Using specific dollar amounts, and not meeting them at times, makes you feel like a failure and a spendthrift. When you use percentages, you’re always a success.

I fixed Social Security—and you can, too!

Most of us are pretty convinced we could do a better job than our politicians. Personally, after my social policy studies way back when at the University of Chicago, I became less certain that even the best intended people could fix all that much, but it hasn’t stopped me from pontificating. The Republican party is welcome to draft me as their presidential candidate. Although I’m a lifelong Democrat, I couldn’t be any worse or more out of synch than the current nominee. But let’s get back to a program that affects all of us—Social Security.

There are about a million scary articles on how Social Security will run out of money, and my younger clients nearly always have a fear that Social Security won’t be there for them. I’ve been hearing that same song since I, myself, was a graduate student and now that I’m closer to circling distance, it’s still there. In fact, in my lifetime government services to the elderly and disabled have vastly expanded and improved, and that’s a good thing. Sadly, Social Security was only designed to put a floor under old-age retirement (in an era when people still had private employer pensions) and it hasn’t kept up with the real need for a basic guarantee of a decent living standard for those dependent on it as principal or only source of income.

Now you can try your favorite policy solution by going to the University of Pennsylvania’s Wharton School Social Security Policy Simulator. This has several slider buttons you can play with to see what change(s) might make the System solvent, or for how long you can keep it afloat. I chose increasing the payroll tax rate from 12.4% (current) to 14.4%, which I think is pretty minimal, and increasing the taxable maximum income to $400,000+ (in other words, just about everybody). If only they would listen to me, instead of running out of money in 2030, the current scenario, it wouldn’t run out of money until 2070.

I was dismayed that my favorite solution (increase the taxable maximum), didn’t solve things on its own. It just makes no sense to me, and never has, to let the highest earners off the hook as they earn more than $118,500. Those who least need the break get the most benefit. However, I hate the idea of any tax raise as much as any blue (oops, red)  blooded American, so I was dismayed that to make it work, I had to give us a tiny tax uptick. For comparison, take a look at this tax summary of employer social security tax rates in other countries. Plenty of countries pay far more than we do, and many pay less.

It’s important to remember here that the US Social Security system was never set up to be a true annuity program. Roosevelt wanted to cover people immediately–low-earning people like my iron miner grandfather–who had never paid into the system but desperately needed old-age support. Often people (again, like my grandparents) would have been too proud to participate in the system if it had been “welfare” but by pitching it as an entitlement program in which everyone would participate, people bought in. But current contributors have always paid for those before them–so it’s not accurate to say, “I paid in and now I want it back” in the same way as an investment or annuity works.

Unfortunately, not all the options I would implement as dictator are available in the UPenn simulator. What about making Social Security benefit amounts a sliding scale based on income in retirement? (Is Donald Trump collecting Social Security?) What about funding it from general revenue? What about some way to assess the economic impact of better benefits instead of throwing people on the general public welfare system, and bankrupting them before getting them there? What about the impact of immigrants earning and contributing?

Curious what the candidates propose? Of course you can go to their websites for details. Hillary Clinton’s proposals are here and Donald Trump’s are here. That’s right, no link. He doesn’t have anything on his website addressing Social Security (not that I could find, at least).

I do invite you to try out your own solutions on the UPenn simulator. If nothing else, you’ll see that it’s not a quick and easy fix. And if you want to take a look at your own personal retirement situation, check in with me—I’m here to help.

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How will working or not working affect my Social Security?

Will Social Security be affected if I work longer, or quit earlier than full retirement age? This question comes up a lot whenever I speak on Social Security strategies, as I did last night at Mt. Prospect Library. As with most things about Social Security, it’s not a snap answer, and it depends on your personal situation. But here’s some pointers.

Situation #1

You’ve been out of the workforce for a number of years: being a stay at home parent, going back to school, taking care of an elderly family member, working for free in a family business.  Can you improve your Social Security benefit by resuming work?

Answer: yes, probably. Social Security benefits are based on your past 35 years of working. So if many of those years are zero, but you can work for 5 or 10 years, or up to 70, you’re going to replace some of those zeros with actual earnings. Obviously, the higher those earnings years are, the more impact they’ll have on the overall average. You’re probably not going to raise it enough to ever collect the maximum possible benefit, but there will be some improvement. Worth it!

Situation #2

You’d like to retire from full time work early (say, 62) but still work part-time with far lower earnings, or none at all. Will this hurt your Social Security benefit?

Answer: probably not much, if at all. It’s true that your Social Security projected benefit assumes that you will work until your full retirement age (66-67, depending on your birthdate). However, if you have 30-35 years of a solid earnings history, a few years of lower paying work won’t affect the average much, especially if you have any very low paying years already (like when you were a kid or 20-something). Even part-time, you may be making more than you made bagging groceries at 17 (even if your part time job at 62 is…bagging groceries). Even though your past historical earnings are indexed to account for changes in average wages since, your wages after 62 are accepted at their face value.

Want to play around with this a little? Try the Social Security Retirement Estimator or the AARP calculator. Or, as part of working with you on a retirement plan, I can try out a few different projected earnings scenarios for you and show you how to project and maximize your benefits, and how these payments affect your overall retirement income strategy.