When you’re an entertainment professional, you may reach that exciting moment where your earnings are high and you’re suddenly feeling pretty darn rich. But as my writer-friend Dave says, you’re not rich in Hollywood until you can live off your investments.
People in “the biz” (actors, writers, producers, etc.) are sometimes launched into a high-earnings, big-spending lifestyle well before they’ve built up a nest egg that could support the lifestyle they had even before their newfound success. While they don’t all have a Johnny Depp $2m-per-month spending problem, they may feel highly confident that the projects will continue rolling in, and spend accordingly.
System for Saving
A typical year might look like this if you work in the biz: Your earnings land in a business account. Your lawyer gets some, your agent gets some, and then your CPA has you set aside a chunk for taxes, and perhaps a retirement account such as a SEP IRA or Solo 401(k) plan. With whatever’s left in the pot, you buy a great home and the rest goes towards, well, life.
This is the key moment your future self really wants you to pause and reflect on how much you need in a year to enjoy some version of a minimum lifestyle. Knowing this is the first step towards knowing how much you might able to tuck away in the high-earning years.
Knowing how much you’ll need to save for the future can be quite daunting for several reasons. The lifestyle you’re enjoying now includes so many expenses that could disappear once you stop working or slow down. You’ll also probably receive income from a guild pension and social security, but you don’t know exactly how much it will be or when it will start, and you might need some cash flow before those kick in. One thing is virtually certain – you’ll need to save a lot more than what you can add to a single retirement account, such as a SEP IRA or Solo K plan.
When Dave talked about feeling rich in Hollywood, he wasn’t referring to the size of a nest egg or how much you spend. He was referring to the point where you can actually own a home in this city and let your portfolio kick out enough income for you to maintain some version of a minimum lifestyle without needing the next project to be a success. Here’s what he’s done.
Saving and Investing First, then Enjoy
Dave first maxes out to his Solo 401(k) and personal defined benefit plans so he can squeeze out every last tax deduction on the way to this goal, while his tax bracket is high. For any surplus income he earns after doing that, he contributes to non-retirement investment account and invests it all for the long run. He has also put enough money aside to pay for the kids’ future college costs. He sticks to mutual funds so that he can stay liquid and keep things simple. If you’d prefer to spend more in the high-earning years, there’s a system for that too.
Avoiding the Real Estate Trap
When income comes in suddenly and in large amounts, an entertainment professional may buy a nice home, then outgrow it quickly and buy another one, but feel reluctant to sell the first one. There may be a better way.
Option one is to simply not buy a home in the first phase of your success. When you sell a home, you probably incur a significant closing cost (5-7% for commissions and other misc. fees). On a $2,000,000 home, that’s an upgrade “toll” of more than $100,000. If you held the house for just 3 years, that’s nearly $2,800 more per month you spent to buy a home for a short period of time. Buying starts to make more sense for most people once you know you can commit to the house for a while (my rule of thumb is 7 years).
Option two (which I see very often) is to buy a new home and rent out the older home. But by doing so, you’re adding a business to your life while you’re at your busiest, and one with a pretty low expected return. In my experience, single-family homes don’t typically provide great returns, unless you have a little luck on your side, and you have the discipline to do it well, even when your tenants are really nice. Plus, if you don’t sell the old house within 2 years of converting it to a rental, you’ll lose your ability to avoid the capital gains taxes that will be due on the appreciation. Before you buy the first house, think about those possible outcomes first.
Dave and his partner avoided both traps opting to be luxury renters until they know that they’re buying a house they can commit to for a while. He’s oh-so-close to his financial-freedom goal and hasn’t even celebrated his 50th birthday. That may very well be the party where he finally feels like one of those rich Hollywood people (but one of the good ones).