Retirement saving for Los Angeles VFX artistson January 8, 2012 at 12:00 am
A few younger VFX artists asked me where they might obtain health and retirement benefits. My initial response was “work at an 839 studio,” but I thought I should outline a few more possibilities.
I write about retirement saving for VFX artists in this post. A few disclaimers: I am a visual effects artist, not a certified financial planner. I also do not cover every option available, only what I consider to be the simplest options. I also do not go into the deepest detail about these options, though I do provide reference links for further reading. If you already contribute regularly to a retirement plan, please feel free to skip this post and come back for next Monday’s comic page.
Why VFX Artists Need To Save For Retirement
Those who don’t plan to work until they drop will need some means of paying for food and housing in their old age. Social Security alone might not be enough.
The Los Angeles visual effects industry does not offer a safety net for its retirees. Visual effects might earn big money at the box office, but VFX artists and VFX studios do not share in those profits. VFX artists do not earn ongoing income from a project after the project ends. When they retire, they’ll be on their own.
The older VFX artists I know already have some kind of plan for their future. Some left the VFX industry for better compensation at 839 studios, and some left VFX altogether. The rest save their money, pay down their debt, work towards home ownership, start their own businesses, create their own intellectual property, invest or practice some combination of the above.
Most of the younger VFX artists I meet are busy paying off student debt and building up emergency funds. They might not be able to do more than save a few dollars for retirement at this time. Still, those who’d like to know more about where they might tuck those few retirement dollars can keep reading.
Why VFX Artists Should Consider Tax-Advantaged Accounts
There’s nothing stopping a VFX artist from stashing a pile of cash under a mattress for the next 30 years. However, the value of that cash will be lost to inflation over time. Comic collectors may have noticed that the sticker price on a printed Amazing Spider-Man comic book went from 12 cents in 1963 to 75 cents in 1980 to $3.99 today. The same held true for the cost of rent, groceries and the electric bill.
There’s also nothing stopping a VFX artist from keeping his retirement savings in an ordinary savings account at a bank or in an ordinary brokerage account. However, the interest, dividends and capital gains earned on those accounts will count as part of the artist’s annual income, and each year the VFX artist must pay taxes on that income. This introduces a small “tax drag” on the compound growth of the savings in a taxable account.
Tax-Advantaged Options for Retirement Saving
Luckily, tax-advantaged accounts allow a VFX artist to separate long-term retirement savings from short-term taxable savings. When a VFX artist saves money in a tax-advantaged account, he does not have to pay taxes on the earnings within that account as long as the funds stay within that account. In exchange for these tax benefits, the artist sacrifices the immediate access of an ordinary savings account.
Here are three of the tax shelters a VFX artist might use for retirement savings.
|2012 rules||Roth IRA||401(k)||SEP-IRA|
|Tax benefit:||Contributions are made with after-tax dollars.
All withdrawals after age 59.5 are tax-free.
|Contributions are made with pretax dollars.
Ordinary income taxes are paid upon withdrawal of funds from the account after age 59.5.
|Contributions are made with pretax dollars.
Ordinary income taxes are paid upon withdrawal of funds from the account after age 59.5.
|Who can contribute:||Single VFX artists who earn less than $125,000.
A single artist who earns $110,000 or less can make the maximum contribution.
Married VFX artists who earn less than $183,000.
A married couple who earns $173,000 or less can make the maximum contributions to each of their Roth IRA accounts.
|Any VFX artist whose employer offers this benefit.||Self-employed VFX artists who earn 1099 income through freelance work.
For VFX artists who work on a W2 basis at a studio while earning 1099 income at home: only the 1099 income qualifies for SEP-IRA contributions.
|Max contribution:||$5000 for those under age 50.
$6000 for those age 50 and older.
|$17,000 for those under age 50.
$22,500 for those age 50 and older.
|20% of your net 1099 earnings up to $50,000.|
|Contribution method:||The artist transfers funds into the Roth IRA account.
For example, the artist can write a check to the financial institution holding the Roth IRA.
|Deductions are taken directly from each paycheck.||The artist transfers funds into the SEP-IRA account.
For example, the artist can make an electronic transfer between his checking account and his SEP-IRA account.
The artist must also claim the year’s SEP-IRA contribution on his tax return in order to get a tax deduction for the contribution. A tax professional like a CPA can help with this part.
|Investment options:||Anything allowed within a Roth IRA, including high-interest savings accounts, CDs, stocks, bonds and Vanguard funds.||The VFX artist is restricted to whatever the employer plan offers for as long as the funds remain within that employer’s 401(k) plan.
After the VFX artist leaves the employer, however, he can “roll over” the funds from the 401(k) into a traditional IRA or an existing SEP-IRA at any financial institution he wants.
|Anything allowed within a SEP-IRA, including high-interest savings accounts, CDs, stocks, bonds and Vanguard funds.|
I like these options because they require minimal paperwork. However, contributions to these accounts can only come from income earned within a given year. For example, if an artist has $5000 saved in the bank from previous years but does not earn any income in 2012, he cannot transfer that $5000 in savings to a Roth IRA for 2012. The $5000 in savings from previous years would not count as after-tax earnings in 2012. If that same artist earns $5000 in after-tax income in 2012, however, he can contribute $5000 to his Roth IRA in 2012.
If an artist qualifies for all three accounts, and if he has enough income, he can contribute to all three — the max allowed for the Roth IRA and 401(k) plus 20% of his net 1099 income to the SEP-IRA.
I strongly recommend consulting a tax professional before making a contribution to a SEP-IRA, because the SEP-IRA rules for the self-employed can make calculating the maximum yearly contribution a bit tricky. If you hire a professional to handle your tax returns each year, that same professional can calculate the maximum SEP-IRA contribution for you.
Two More (Simple) Options
Sometimes one or more of the above options are not available to the VFX artist. Not many Los Angeles VFX studios offer 401(k) plans. Bigger studios like Rhythm & Hues, Digital Domain and Sony Imageworks offer them, but few of the smaller shops offer retirement benefits to their artists. Not every VFX artist qualifies for SEP-IRA contributions, because not every VFX artist earns freelance income in a given year. Some lucky VFX artists earn so much in a year that they do not qualify for Roth IRA contributions.
If a VFX artist does not earn any taxable compensation in a given year, that artist cannot contribute to a Roth IRA, 401(k) or SEP-IRA for that year. I knew one VFX artist who took a year off after giving up all his spare time for years on a major feature film project. I also know another VFX artist who took a year off to work on personal projects. These artists could not have used Roth IRAs, 401(k)s or SEP-IRAs for retirement saving during those years.
On the flip side, a VFX artist might make the maximum possible contributions to his Roth IRA, 401(k) and SEP-IRA, have no debts, have a healthy emergency fund and still have a few bucks left over for retirement saving.
For these artists, where might extra retirement savings go?
U.S. Savings Bonds
Any U.S. citizen or permanent resident can buy and hold U.S. Savings Bonds through Treasury Direct. The owner does not have to pay taxes on the interest earned by the savings bond until it is redeemed or until final maturity, whichever comes first. Since a savings bond reaches final maturity after 30 years, this translates into up to 30 years of tax-deferred growth. Plus, the interest earned on a savings bond is exempt from state and local taxes.
A U. S. savings bond is not as convenient as a savings account at a bank, however. Once purchased, a savings bond must be held for at least one year before it can be redeemed for cash. If redeemed within five years, the owner loses the last three months’ worth of interest as a penalty. After holding a U.S. savings bond for five years, however, the owner can redeem the bond at any time without penalty.
There are two kinds of U.S. savings bonds: EE and I. Americans and permanent residents are allowed to buy up to $10000 of each kind of savings bond each year. The EE bonds pay a nominal fixed rate and are guaranteed to at least double in value after 20 years have passed. If they fail to double in value by their 20th year, the Treasury will make a one-time adjustment to make up the difference. Despite this guarantee in nominal value, however, it’s not guaranteed that EE bonds will actually keep up with inflation. It doesn’t matter if the dollar value of the bond doubles in 20 years if the price of goods triples over the same period of time.
Inflation is where I Bonds come in handy. I Bonds pay both a nominal fixed rate and an inflation-linked rate. Twice a year the inflation-linked rate changes to match the Consumer Price Index. So instead of a steady, fixed rate like an EE bond, the interest rate on an I Bond goes up and down each year with inflation. If the composite rate ever turns negative, the bond will retain its value from the preceding month. The value of the bond can go up, but it will never go down.
Savings bonds are not a way to get rich. At best, they preserve one’s savings for the future. After being held for at least one year, savings bonds can also double as emergency reserves if a VFX artist finds himself out of work for an extended period of time. This makes I Bonds an ideal choice for surplus retirement funds.
Vanguard Total Stock Market Index Fund
Purchasing the Vanguard Total Stock Market Index Fund (VTSMX) in a taxable account would be my second choice for surplus retirement savings. This fund holds 3,344 stocks for the rock-bottom cost of 0.18%. So a VFX artist gets whatever the entire United States economy has to offer, minus 0.18%. For example, if the United States stock market as a whole goes up 7% in one year, the artist will get 6.82% from the Vanguard Total Stock Market Index Fund.
That is, 6.82% before taxes. When held in a taxable account, the Vanguard Total Stock Market Index fund will regularly generate small amounts of taxable income in the form of quarterly dividends and occasional capital gains distributions, and the owner must report this income each year on his tax return. The VFX artist must also pay taxes on the profits earned whenever selling some or all of the fund. If the artist invests $3000 in this fund and later sells all of it for $4000, the artist owes tax on the $1000 earned in capital gains.
Although the artist must pay taxes on the income received from the fund each year, he can control when he chooses to sell the fund and thus control when to pay taxes on the capital gains earned from the sale of the fund. Plus, the Vanguard Total Stock Market fund follows a “buy-and-hold” strategy that is unlikely to realize capital gains distributions for its owners. This might not be tax-deferred growth, but it’s definitely tax-efficient growth.
Because stocks can lose money in the short term, a stock fund cannot double as an emergency fund. It can only be used for long-term savings goals like retirement.
So, to recap:
|2012 Rules||Series I Savings Bonds||Taxable account – VTSMX|
|Tax benefit:||The bond owner does not have to pay taxes on interest until the savings bond is redeemed.
Interest earned is exempt from state and local taxes.
|If the fund increases in value, the owner does not have to pay any taxes on the value increase (“capital gains”) until the fund is actually sold.|
|Who can purchase:||Any U.S. citizen or permanent resident.||Anyone with an account at Vanguard.|
|Max purchase limit:||$10,000||No limit.|
|Purchasing method:||Electronic transfers from a checking or savings account to the artist’s account at Treasury Direct.||Electronic transfers from the artist’s checking or savings account to his account at Vanguard. The artist can also mail a check to Vanguard.|
|Additional notes:||An I bond must be held for a minimum of one year before it can be redeemed for cash.
If redeemed before five years have passed, the bond owner loses the last three months’ worth of interest as a penalty.
|The fund will generate small amounts of taxable income each year, and the owner must pay taxes on that income.
Because the stock market can go down as well as up in any given year, this fund cannot be used for short-term savings. It works best for long-term savings goals like retirement.
The above barely scratches the surface of retirement planning. If anyone’s interested in further reading after slogging through the above post, here are some links:
- The Bogleheads Wiki
- “The Saga of Anne Scheiber” by Steve Hulett
- “Two 50-year Careers. Two Different Stories” by Steve Hulett
- “Nobody Cares More About Your Money Than You Do” by Get Rich Slowly
- “How to Start a Roth IRA (and Where to Do It)” by Get Rich Slowly
- “Outfox the Box” at The Coffeehouse Investor
- The truth about costs at Vanguard
- “The Long Term Cost of High Investment Expenses” by Scott Burns
- “On the Importance of Being a Dull Investor” by Scott Burns
- “The Margarita Portfolio” by Scott Burns
- Quotes from William J. Bernstein’s The Investors Manifesto
- “An Open Letter to Joe Nocera“ by William J. Bernstein
- “The Executioner of Excellence“ by William J. Bernstein
- “The Longest Discipline” by William J. Bernstein