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Musings Report #19 5-9-15 Financial Independence via Self-Employment: How Do We Do It?
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Financial Independence via Self-Employment: How Do We Do It?
The conventional financial industry touts gaining financial independence by playing Wall Street's game: working for decades in a conventional job and saving a vast sum of money in retirement funds that Wall Street wizards magically squeeze for hefty annual returns in a zero-yield world--in a completely risk-free manner that keeps your nest egg intact, of course.
This large annual yield on the mega-bucks squirreled away over the decades then (supposedly) enables a spacious retirement home on the golf course, luxury cruises, etc.
The other pathway to high-income retirement is to manage your working career to earn multiple government pensions: in areas with large Dept. of Defense working populations (military and civilian), this often means 20 years in military or civil-service that comes with a pension and healthcare benefits, followed by a second career in another government agency and secures two more pensions--Social Security and a second government retirement plan.
Another pathway is to have two people in the household retire with a government pension and Social Security, so the household income includes four secure pensions.
The third avenue to financial independence is not so much about retirement--it's about financial independence during your career/working life as well as retirement--though the ideal scenario for the self-employed is simply a reduction in the work you don't much like and a continuation of the work you enjoy until the end of your life.
Self-employment is part of the core mythology of the American Dream--working for yourself as the ideal form of work. Self-employment's place in the pantheon of American ideals did not prepare me for startling reality that a mere 5% of the workforce (about 7.4 million out of 145 million) earn a middle class living as self-employed workers (i.e. sole proprietors or partnerships/S-corporations with no employees).
I laid out the statistics in Endangered Species: The Self-Employed Middle Class. According to the source, there are roughly 6 million small businesses with employees. While running a small business with employees is certainly working for yourself, the requirements in terms of management, experience and capital are far more daunting than sole proprietorship, which is why I'm focusing only on the 7.4 million sole proprietors (out of 22.5 million) who make $50,000 or more annually.
Of the 22.5 million enterprises with no employees, 3 million are partnerships or corporations. These tend to be professionals: engineers, architects, physicians, accountants, etc. That leaves about 19.4 million sole proprietors who are typically not licensed professionals with advanced degrees.
According to the sourced analysis, only 20% (4.5 million) of the 22.5 million self-employed earn $50,000 or more annually. If we subtract the 3 million professionals, that leaves only 1.5 million self-employed who are earning a quasi-middle class living. That is just about 1% of the workforce. (As we shall see, IRS data says there are 7.4 million self-employed earning $50K and up, which leaves 4.5 million non-professionals earning $50K and up.)
This picture isn't entirely complete, however; unearned income, for example, from rental properties or family trusts, is not recorded as self-employed income (Schedule C); rental income is reported on Schedule E, and these earnings are not subject to self-employment payroll taxes (15.3%, as the self-employed pay both the employee and the employer portions of the payroll taxes).
So someone who owns rental properties could be financially independent and not be considered self-employed, even though they actively manage their properties.
There are a number of interesting statistics in the IRS spreadsheet "Table 1.4, All Returns: Adjusted Gross Income, Exemptions, Deductions, and Tax Items for tax year 2012" that help us understand how the self-employed earn their income.
This data tells us how many people are earning middle-class incomes from rental properties, royalties and earned income.
The IRS reports that 18.7 million taxpayers paid self-employment taxes, and 7.4 million of them earned $50,000 or more annually. This is roughly 3 million more $50K+ earners than the other source calculated and almost 4 million fewer self-employed. What accounts for the difference?
I don't have a definitive answer, but since the incorporated self-employed (the IRS reported 4.3 million partnerships and S Corporations netted $50K or more) paid themselves through the corporate structure, they are not "self-employed," they are employees. It may also be a matter of how certain types of income such as royalties are reported.
In any event, the 7.4 million taxpayers who paid self-employment tax and earned $50K or more represent about 5% of the workforce--still a thin slice of the workforce.
8,214 of these self-employed raked in $10 million or more annually. (I presume this includes athletes, film stars, etc.)
4.8 million people reported positive rental income, of which 2.95 million reported earning $50,000 or more in rental income annually.
1.25 million taxpayers reported earning $50,000 or more in royalties annually. (7,585 reported earning $10 million or more in royalties--subtracting Steven King and a few musicians, who else earns these princely sums? I suspect most are patent royalties.)
As I noted in my essay, only 2.4 million earners deducted healthcare insurance payments. This suggests that many of the self-employed are in households where someone is working as an employee and getting healthcare coverage for the household from their employer. Alternatively, millions of self-employed don't have any healthcare insurance. This seems unlikely.
So what does all this say about self-employment? I think we can draw a few conclusions:
1. Establishing a profession is one tried-and-true way to be self-employed. Obtaining the diploma and license does not guarantee an income, of course, as competition can be plentiful in some professions and regions.
2. Owning rental properties is a path to financial independence that works for almost 3 million people/households.
3. Owning the rights to creative content or patents that generate royalties is a ticket to financial independence for 1.25 million people.
4. There are many other sole proprietorships (about 3 million based on the IRS data) that manage to net $50,000 or more annually. Presumably some qualify as Mobile Creatives who cobble together several income streams to generate enough to live independently.
5. Over 10 million people are earning meaningful sums from small (less than $50K/yr) enterprises, rentals and royalties. These don't generate $50,000 a year, but they still make an important contribution to financial independence, income and capital/wealth.
6. Businesses that eventually earn $50,000 or more typically start small, so many of the people currently earning less than $10K/year could over time increase their income or add another modest income stream.
Financial independence is still possible, and there are many pathways to that goal. The path I consider the most flexible and thus the most attainable by non-professionals is the Mobile Creative idea of generating multiple income streams, preferably from sources that are not all tied to the same industry so that a downturn in one sector won't wipe out the entire household income.
Summary of the Blog This Past Week
Thank You, Readers, for Of Two Mind's 50 Million Page Views 5/9/15
Tax Donkeys: Rich Enough to Pay Most of the Taxes, Not Rich Enough to Buy Politicians 5/8/15
Bank Reserves and Loans: The Fed is Pushing On a String 5/7/15
No Wrongdoing Here, Just 6,300 Corporate Fines and Settlements 5/6/15
Collaboration, Adaptation and Risk: Innovate or Die 5/5/15
Endangered Species: The Self-Employed Middle Class 5/4/15
Best Thing That Happened To Me This Week
Meeting with my longtime friend and collaborator A.G. that resulted in key insights into my current writing project. Having insightful editors is an enormous asset for any writer.
Market Musings: Extreme or the New Normal?
I've marked up a chart of the S&P 500 (SPX) from 1994 to the present to highlight two measures of extremes: the time MACD spends above the zero line (i.e. very bullish) and the point spread between the peak and the 200-week moving average (MA).
Currently, the SPX is almost 500 points above its 20-day MA. This is considerably higher than the 350-point spread reached at the top in 2000 or the 250 points in 2008. This simple metric suggests the SPX has reached extremes that have marked long-term tops in the past 15 years.
From Left Field
Anti-Intellectualism and the "Dumbing Down" of America -- long-term trend?
Start-Up Blends Old-Fashioned Matchmaking and Algorithms -- new Normal dating based on data...
Regulation Run Amok—And How to Fight Back
The Utopia of Rules: On Technology, Stupidity and the Secret Joys of Bureaucracy by David Graeber – book review
The Pitchforks Are Coming… For Us Plutocrats (via Joel M.) -- from last year, but worth a read if you missed it:
"No society can sustain this kind of rising inequality. In fact, there is no example in human history where wealth accumulated like this and the pitchforks didn’t eventually come out. You show me a highly unequal society, and I will show you a police state. Or an uprising. There are no counterexamples. None. It’s not if, it’s when."
If European Countries Were US Corporations -- Apple is larger than entire nations in terms of market cap to GDP...
How America’s most famous farmer can appeal to left, right and center -- gasp--you means there could be middle ground in America?
What’s It Like to Fight in 15th Century Armor?: A Surprising Demonstration
6 Freeway Removals That Changed Their Cities Forever -- neat to see how effective this strategy is...
Why We Have an Oversupply of Almost Everything (Oil, labor, capital, etc.) -- short answer: stagnating income for the bottom 90%...
The Wonderfully Elusive Chinese Novel -- worthy essay on the difficulties of translating completely different languages...
Jascha Heifetz - Portrait of an Artist (video) -- worth a look if you're interested in music and musicians...looks dated to modern eyes but the message is timeless...
"The things that will destroy us are: politics without principal; pleasure without conscience; wealth without work; knowledge without character; business without morality; science without humanity; and worship without sacrifice." Mohandas (Mahatma) Gandhi
Thanks for reading--
charles |
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