Personal Finance for Musicians
/When I was young I was taught to save. When I was in college I was excited to spend my savings - on a camera, a car, and a computer. I spent all my savings.
Now I look back at those lessons from my youth and realize that “savings” really means two things so I’m going to start my version of this lesson, to you, with an updated message.
In your “household” business, there are three buckets of money out of which you operate: checking for monthly needs, money market for annual needs or emergencies and investment accounts that you don’t touch until you can live off of the returns.
The first bucket is a checking account for your monthly “nut” to use a music biz term. This your daily/monthly cash need. This includes rent/mortgage, car payment, gas for the car, groceries, utilities, and the like. You can count on these costs to be roughly the same throughout the year. This money is kept and spent out of a checking account.
The second bucket is a money market account or other high yield savings account that you use for either emergency or for annual or non-regular expenses. Many personal finance experts recommend six months of living expenses for this account. Personally, I transfer a set amount of money each paycheck into this account and then I use this account to pay for annual vacation, unexpected house repairs, sometimes tax bills, and of course it’s there as an emergency fund in case it’s ever needed otherwise. Say your primary income derives from touring and you injure yourself and can’t tour or make money for a period of time, this fund could help you through that period. I think that this bucket is what many people refer to as “savings” when they tell you to save.
The third bucket of money is the general category of investments which you do not touch until such a point that you live off of them. This is the category that I think people fail to mention when they discuss savings. You put money into this “bucket” and you don’t touch it under any circumstances until either you can live off of 4% of the total invested or you get to retirement age and you are forced to take money out (if it was invested in retirement accounts).
Financial Independence is having enough money in bucket 3 that you can live off the returns.
If you follow the theories of modern personal finance, then the main idea is to save enough money in the third bucket that you can live off of it. That is what is called Financial Independence. Most financial advisors say that if you figure out how much money you need to live each year, you can divide that number by .04 (or multiply by 25) to get the total amount of invested money you need to live on without any other income source. The idea here being that this money is invested in the market (index funds, etc) that will yield on average more than 4% per year. Say you need $30,000 per year to live; multiply that by 25 or divide by .04 and you get $750,000. This amount of money invested will yield you at least 4% per year in returns and thus you will have your $30k per year income from your investments - no need to do other work. Again, this is called Financial Independence.
You may be looking at the three buckets of money and saying to yourself, ‘this makes sense to me but i’ve never been able to move beyond the first bucket.’ You may live day-to-day with your income and expenses.
Framework for Steps toward Financial Independence
Let’s get some framework for how you move from bucket 1 onward. Joshua Sheets of Radical Personal Finance has discussed what he considers the Seven Stages of Financial Independence.
Stage 0 – Total Financial Dependence. Everyone starts here. When you’re a child, for example, you’re dependent on grown-ups.
Stage 1 – Financial Solvency. You can support yourself, without help or handouts from others, and you’re current on your bills.
Stage 2 – Financial Stability. You can support yourself, your bills are current, and you hold some savings.
Stage 3 – Debt Freedom. You’re debt-free, in addition to the points above. It’s your choice whether or not you want to include your mortgage within this definition. (Joshua elaborates on debt paydown during Episode 32 of his show.)
**My notes here: There can be a lot of time between stage 3 and 4 and likely many musicians will be beyond Stage three but not yet at stage 4
Stage 4 – Financial Security. You have enough investment income to cover basic, bare-bones living costs.
Stage 5 – Financial Independence. You have enough investment income to cover your current lifestyle.
Stage 6 – Financial Freedom. – You have enough investment income to cover BIG dreams and upgrade your lifestyle.
Stage 7 – Financial Abundance. – You have enough investment income that you cannot possibly spend this money. Vast amounts of your money will outlive you, and your focus is wise stewardship of this wealth so that you can leave a beautiful legacy.
Moving toward financial independence is more about your spending and psychology than it is about how much you earn.
With this context in place, a natural question may be, ‘how do I move forward from Financial Stability or Debt Freedom?’ Make more money is certainly part of this equation but there are many excellent writers and thinkers who challenge the assumption that making more money is the answer. As can happen with humans, the more we make the more ways we find to spend it. There is a lot of psychology involved with having enough, knowing what that level is and just stabilizing there. If you can do that, then when more money comes into your accounts you can funnel it to your bucket 3 or bucket 2. It would be impossible to list all of the ways you can focus on cutting costs and saving money so I’ll list some of my favorite writers who tackle these topics here:
Mr Money Mustache: His primary focus is on financial independence through frugality and smart living. Humorous yet serious writer.
Early Retirement Extreme: This man learned to live below the poverty line and invested the rest. The book is an interesting one, worth the ready
Your Money or your Life: this one is considered to be the first Personal Finance book written in the FIRE (Financial Independence Retire Early) community.
How to reduce one of your biggest expenses - Taxes!
Part 1 - Claim all possible Business related Expenses
This post is dedicated to Personal Finance. By definition this is the money that flows into your personal accounts or what I call the “household business” - it’s the profit from your music business endeavors. But for a quick moment I want to touch on your music business endeavors. On the business side of your affairs, before the profits flow to your “household business” you have the opportunity to claim many business related expenses. Please be smart about this process and claim all of those expenses. I won’t go into it all here but the list can and should include:
Mobile phone bill
Home office deduction
Instrument repair and maintenance
Computers and software and subscriptions for services
Education and reference (lessons, etc)
All business meals
Travel meals - be sure to ask your accountant or business manager about claiming gov’t per diem rates for every city you travel to. If you generally spend less than $50 per day in meals you could claim the gov’t rate under an accountable plan and save lots of tax dollars.
Part 2 - Retirement Accounts
The greatest way to reduce your income tax bill *and* move yourself forward on the path to Financial Independence is tax advantaged retirement accounts. For every dollar that you put into tax advantaged retirement accounts through the year you will save roughly $.20 (20%) in taxes not paid. So if you save $1000 into retirement accounts this year you would save roughly $200 in your tax bill. Ask your accountant for specific figures when the time comes.
Since everyone’s personal situation will be different, I won’t go into the specifics, but will instead lay out the general structure of retirement accounts here.
You have access to two main classifications of retirement accounts:
Business side accounts
Personal side accounts.
Business Side (Workplace) Retirement Accounts
On the business side if you own your own business you can set up a SEP IRA or a i401k also called a solo401k. Initially for my wife who is a photographer we had a SEP IRA set up and then after reading further about the solo or i401k I found that you could actually contribute more money to it annually so we switched. You can ask your accountant for specifics but the i401k seems like the best bet to me.
On any given business retirement account there is the Employer Contribution and the Employee Contribution. This pertains to a business that sets of a formal 401k or for a single member LLC that does an i401k.
The Employer Contribution (of the business side retirement account) is going to be dependent on either the profits of the business or the salary of the employee.
If you are an owner/employee of an S Corp then this amount will be dictated by your salary and the rules of your 401k. Many of the businesses I work with use Guideline 401k and Gusto payroll. We have the Guideline 401k set to a maximum employer contribution of 6% of the employee’s salary.
If you a single member LLC then the max you can contribute is 20% of the net income (subject to limit of $61k total)
The Employee Contribution is up to the individual - either the employee or the solo member of the LLC. On this side you can contribute a maximum of $20,500 for 2022!! At a 20% tax savings (estimated) that would be $4100 in tax savings! If you have the means, max this one out.
In total, on the Business side of retirement accounts you can invest $20,500 (employee) plus whatever the employer side can contribute - ask your accountant at tax time.
Personal Side Retirement Accounts
On the personal side, regardless of your business retirement accounts you can have an IRA. There are two types of IRA - one is a Roth IRA and the other is the Traditional IRA.
The Traditional IRA reduces your tax bill now - so the money goes in pre-tax, but then it is taxed when you take it out. Personally I prefer this since I expect to have a lower tax bracket in the future than I do now. I’d rather have the tax benefit now.
The Roth IRA money goes in post-tax so it doesn’t reduce your tax bill now, but when you take it out the money is tax free. In both cases the investments grow tax free.
I think the MadFientist is the best writer on these topics so I’ll link to his post on this matter. And another: https://www.madfientist.com/stack-tax-benefits/
The max you can contribute for 2022 is $6000 per person into one of these accounts. These are also subject to overall income limits if you are also contributing to a business side retirement plan.
Health Savings Account (HSA) as Retirement Account
Last but not least, you can also reduce your taxable income by making contributions to an HSA. If you have a high deductible health insurance plan with an HSA attached, like I do, then you can contribute $3650 (or $7300 per family) to an HSA account in 2022 and invest that money like it’s a retirement account. If you don’t yet have this type of insurance coverage check with your insurance broker to see if this type of policy might make sense for you. The intention is to have that money put aside to cover medical expenses tax free and my understanding is that you don’t need to draw that money in the year that the expense occurred. You can hang onto the receipts and reimburse yourself at some point in the future while letting your money grow in the meantime. As always, discuss with your Accountant.
Here is a read from the MadFientist where he explains this strategy in detail.
Combining the 401k, the IRA, and the HSA you could be contributing tens of thousands of dollars each year to retirement accounts - the max would be somewhere around $60-70k per year per person. Once these are maxed out annually you can look into traditional investment.
With all of the above said, you should have the framework and deep dive reading links to get you moving on the path from Financial Dependence to Financial Abundance.
A couple of books that I highly recommend that didn’t make the links above:
Quit Like a Millionaire This is my favorite personal finance book right now. I’ve read parts of it twice. Written by a thirty some year old who grew up financially poor in China, she and her partner lived frugally and invested and retired early, living on $40k per year. It’s an excellent read that flows well but contains lots of good technical information as well.\
The Simple Path to Wealth Written by JL Collins, who is a well respected writer in the FIRE (financial independence retire early) community. JL was not interested in retiring early, but he was interested in smart investing and living. What made him famous in the community was a series of posts on stock investing or index investing which was turned into this book. I will often say that getting your money into a retirement account is like getting it into a Garage, but then you need to pick what kind of car in the garage you are going to put that money into - a station wagon (think government bonds) or a McLaren (think an individual stock that might be sexy and fast but hard to predict) or a Volvo (index fund - safe and good performance). JL talks a lot about what kind of car you want in the garage.
A final note about the above systems: Everything is temporary and We are a Product of our Environment
A note here to put all of this in context: What is laid out here is a summary of the research and personal trial and error that I have implemented. This speaks only to the modern personal finance theory and doesn’t really reflect whether this whole system is good or the best use of human brain power. :) As with all things this theory is temporary and doesn’t address humanity’s long term challenges.
I say modern because the 401k was only invested in 1978 and the IRA invented in 1974. The very idea of retirement was only invented in the late 1800s. And the idea of index funds only started in 1960. This is modern and we do not know how long this model will last but it is the predominant model now. It will almost certainly continue to exist in our lifetime but beyond that I can not say.
I say temporary because this model is based on endless growth (more humans consuming more things) What happens to the stock markets and our whole financial system as the world population decreases in the coming decades. With less people to consume products and services, I assume economies contract and maybe then a More Beautiful World will be built.
I also want to mention that I have ready many books on our current financial system and all of its flaws. In this category I highly recommend Sacred Economics by Charles Eisenstein and for a bit more technical insight (the first book I read on money system design) The Future of Money by Bernard Leitar. There are many people who I admire, including Charles Eisenstein, who believe that the only real security you get is through your deep social connections and in some cases don’t even attempt to save but rather make it a point to distribute all of their money to other people at all times. It’s amazing, and to me very brave… mostly because I’m stuck in the tyranny of the modern system. In times when you need them, would you rather have a deep network of friends and family or a fat bank account?