I got my bachelors degree in accounting, and up to this point, I don’t think I’ve fully appreciated how scary finances and taxes can be for new freelancers.
I was talking with several writers the other day and realized that many of them had never even heard of an IRA, let alone an individual 401k (the account I use to reduce my tax payments by $7,000+ every year).
In this episode, I give you three simple tax tips that will make your life easier AND put a lot more money in your pocket… or at least your retirement savings.
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Hey guys, welcome to Write Bites: a series of 10-minute episodes on writing, marketing, and freelancing.
In this episode, we’re going to be covering three tax tips that are relatively simple, pretty easy to implement but could be incredibly effective, especially if you’re doing your own taxes. And even if you’re working with a tax professional, these could be pretty helpful for you as well.
So with that said, let’s dive straight into it.
Tip #1: Keep Your Business & Personal Expenses Separate
The first and simplest tax tip is to set up a separate business account and card that you use to cover your expenses.
Probably the biggest hassle that many freelancers have coming to the end of the year is sitting down and going through their expenses and categorizing them by which of them are business expenses and which of them are personal expenses. And if you’re running all of it through the same card, it’s just going to be a huge chunk of time.
There’s just a lot of ways that things can slip through the cracks. And it’s just a whole lot of hassle that you really don’t need to have.
Setting up a business account is super easy. And then having a dedicated card, you can just run all your tools, any expense that you entail, – regardless of what you’re doing – can run through that card and it just makes it really easy to calculate at the end of the year. I’m really glad. I took way too long to do this, and I’m really glad that it is now in place because it makes things a lot easier for me. One less thing to think about. It’s one less thing to track.
Revenue usually pretty simple because you’ll funnel most of your revenue through the same places and it’s just the actual revenue payments tend to not be such a high number that its a pain in the ass to sort at the end of the year.
Expenses, on the other hand… it just can be, you know, hundreds and hundreds of line items. Even little small stuff. So something I recommend: set up that business account. It’ll make things a lot easier, especially if you’re doing your own taxes.
But even if you’re working with a tax accountant – like I do – I still have to send him the full list. Like I still have to send them the itemized list. So regardless, I highly recommend that.
And in a similar vein, track your revenue and expenses monthly, – at the end of every month, instead of at the end of the year.
Tip #2: Tracks Your Income & Expenses Monthly, Not Yearly
Just from a highly practical standpoint, you’re going to end up catching expenses that you didn’t realize were still rolling.
I once found out at the end of the year that a SAAS tool I wasn’t even using – that I hadn’t even signed up for their paid account – had been charging me for the entire year. And it was a substantial amount of money.
If I had caught that earlier, would’ve saved me a bunch of money. Finding stuff like that is something that tracking monthly is going to help you with.
And in a similar vein it also just gives you a better handle on how your business is actually doing.
One of the things that happens as a freelancer is there’s these peaks and valleys, and sometimes it can feel like you’re doing really well when maybe, you know, it’s just that a certain payment came in, from something you completed a month or two ago . Or you might have moments where you feel like you’re not making a whole lot of money but you actually are.
Just like basically tracking each month and having that profit and loss those numbers visible. So you can look in and say: Hey, here’s exactly what my revenue and profit has been over the last three months, over the last six months. It’s just very helpful to gauge how your business is doing…
And it allows you to figure out too if you need to make adjustments, you know. If you see that “Hey I’m hitting certain metrics and certain targets”, or “I’m consistently climbing”, “if I look over the last six months, my revenue is on an upward trend”, then that’s a good sign that what you’ve been doing is working and you should double down on it and continue doing more of it.
Similarly, if you feel good, but you look at your P & L and you see that “Hey, revenue is actually stagnant or even in a downtrend”, then that can communicate that it’s time to switch things up, or it’s time to look for a different strategy to grow the business.
So both of those: relatively simple, super easy to do, you can start right now. Go through and calculate up your revenue and expenses from January, and then just start getting in the habit of doing that at the end of each month.
#3: Maximize Your Tax Advantage Accounts
Okay, so number three is maximize your contributions into your tax advantage savings accounts.
Now, if you’re not familiar with any of the words I just used: basically, if you’re in the US, the IRS has designated certain types of retirement accounts to give you an advantage when it comes to taxes.
So typically when we’re talking about investing for retirement… If you were to open a stock account and put $6,000 in there, that $6,000 is subject to taxes in the sense that you’re going to pay taxes on that amount.
If you earn $6,000 this year in income, and you put that money in this account, you will still end up paying $6,000 on that income.
And then, that money goes in there. Let’s say you have it in there for 20 years. It jumps up to, $30,000. And then you pull it out.
You would then pay capital gains tax if you had held the investments that you had in there for the full time or for more than a year – which is 15%. So you’d pay 15% on the increase from the $6,000 up to the $30,000.
So you pay taxes on the way in, and then you pay taxes on the way out.
A tax advantage savings account allows you to skip one of those tax moments.
For example you’ve probably heard of an IRA. There’s two sorts of IRAs: a Roth IRA, and a traditional IRA.
With a traditional IRA, you are going to not have to pay taxes on any money that you stick into the IRA. The max you can put it in is $6,000. So you basically get to put $6,000 of income in tax-free . If your marginal tax rate is in the 30, 30 percentile, you’re saving like a little over $1,000 or something like that.
So that’s $1,000 less you have to pay – $1,000 to $2,000 less that you have to send to the IRS. So that’s nice. You get to save it then.
As the money grows, when you take that money out – and with tax advantage accounts, you can’t take the money out until you’re in your sixties. Think like 65 or something. If you take it out before then there’s penalties. So there’s some issues there. But it allows you to put more in because you have to pay less taxes now.
And then when you take that money out, down the road, you’ll basically pay income tax on whatever amount you take out.
So say you’re retired and you stopped working. All the money you’ve stuck in there is up to, you know, $1 million, $2 million. You take out $50,000 each year, you’re going to pay taxes on that $50,000 as if you are earning $50,000 in income per year or something like that.
All About Roth IRAs
The other side of that is the Roth IRA.
So with the Roth IRA, you are going to still have to pay taxes on any money that goes into the account. So take your income after taxes, and then you can put $6,000 of that into the account . Any growth on it now – you won’t pay any taxes on. Put $6,000 in per year and when you get into your mid sixties – say you retire – all that money comes out tax-free. You don’t pay any taxes on it.
A lot of people argue that the Roth IRA is the better choice, mostly because there’s the belief that taxes will increase into the future. And also that your income is going to be substantial enough due to investing and things of that nature into retirement that any money you take out – the tax rate coming out as income is going to be a lot higher than it would be for the savings you’re having now. So that’s the argument there.
I like the traditional at the moment just because my – or at least I did – just because my initial goal when I first started saving for retirement was to hit a certain threshold that I felt would secure a comfortable, relatively comfortable, still frugal retirement. For me, the goal was I just wanted to get $100.000 into that account.
By the time I’m coming out into retirement: if everything else blows up, if all my businesses fail, if all my income has disappeared, if all my other investments drop…
That little chunk right there – just sticking it in safe, low-cost index funds over a 30-year period is going to allow me to have a survivable retirement where I’m not having to depend on my kids to take care of me.
So that was my goal. Get there as quickly as possible. And the way I did that, and the reason I went with the traditional account was actually because of this one other account that, even if you’ve heard of an IRA, you probably haven’t heard of this and that’s an individual 401k.
Individual 401ks – Your Secret Weapon For a Safe Retirement
This is something that self-employed individuals can open and it actually allows you to put a lot more money into a traditional account than a traditional IRA.
So with an IRA, the max you can put in is $6,000 a year.
With an individual 401k, you can put up to $57,000. So a whole lot more.
And it does depend on your income, the higher your income, the more you can put in. But basically for me, over the last three years, I’ve been putting in $30,000 into this account every year.
And that’s saved me around… $7,200, I think is what the amount is – in dollars – in direct tax liability every year. That’s $7,000 I would have been writing a check to the IRS for.
And instead, by putting $30,000 of my money into this retirement account , I get to keep that money, stick it in the account and put it towards 30 to 40 years of compounding.
Because my goal wasn’t necessarily to create this really aggressive portfolio, I wanted to hit this certain threshold where I felt like my retirement – you know, assuming the world doesn’t end before I retire – I would have the money I needed to just know in the back of my mind “that’s there, it’s going to be compounding over the next 35, 40 years”, and I wanted to hit that threshold as quickly as possible.
So I opted to go with the traditional 401k route and that’s there for you as well. If like me, you’re looking to first build a lower, maybe lower risk, lower return, but stable thing that you can depend on for down the road, that could be a great option.
It just lets you put a lot more money in then if you were going just an IRA, the IRA route, and now, I’m 30. And looking into this next decade, I’m looking to take a little bit more risk with my additional investments. I have a lot of money I’ve been investing in crypto and some kind of riskier high-growth stocks.
If this blows up in a positive way, that’s going to drastically increase my net worth quickly. If it blows up in a negative way, it’s okay. I still have my business that’s bringing in income and I have that retirement account secured and in low risk and a low-risk portfolio that’s going to continue to compound over the next 35 to 40 years.
So anyway, I hope that was helpful and I will catch you in the next episode.
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Do you agree? Do you disagree with the fierce heat of a thousand suns?
Let me know in the comments below.
Plus, if you have a question you want answered on a future Write Bites episode, ask in the comments or shoot me an email, and I’ll add it to the schedule.