When you gave up the 9-to-5 job to become a digital nomad, you gained freedom, independence, and the opportunity to roam the world. Yet, for as many perks as the lifestyle affords, there are also a few hurdles to overcome. One is taking responsibility for your own financial planning, including savings, retirement, and taxes.
Before becoming a globetrotter, your job compensation may have included a retirement plan, insurance, and loads of other benefits. Looking at what you gave up may cause a bit of a panic attack, but don’t worry. Financial planning is a skill every digital nomad must cultivate to plan for their future without an employer’s assistance. Plus, your new skills will help you to budget for other things, like the next journey to some far-off destination. To sustain the digital nomad lifestyle, here are some tips and suggestions that will help you become a finance guru.
Financial Planning Guide for Taxes
Understanding taxes is one of the digital nomad keys to success, but it’s also a source of anxiety. In fact, April 15 is perhaps the most dreaded day of all for digital nomads, especially if it’s your first year away from the U.S. If you don’t plan carefully, you can owe thousands of dollars in taxes and hinder other aspects of your financial planning. However, there are many methods to brace yourself for your tax liabilities.
Paying Estimated Taxes
Estimated taxes are foreign to many digital nomads, typically because they’ve never been self-employed. Yet by paying an estimated quarterly amount on your income, you can eliminate a lump-sum payment at the end of the tax year. Payments are due April, 15, June 15, September 15, and January 15.
Typically divided into two categories, estimated taxes include self-employment tax and income tax. Self-employment tax is a 15.3% tax that’s levied on self-employed individuals, freelancers, and contractors. When you’re an employee, your employer takes 7.65% out your paycheck and matches it for a total of 15.3%. However, the federal government sees digital nomads as both an employee and an employer. That’s why you’re on the hook for the total amount.
This 15.3% tax does contribute to your future though, with 12.4% going toward Social Security, and the remaining 2.9% covering your Medicare/Medicaid costs. To start your estimated tax budget, take this 15.3% right off the top of any income you earn.
The next portion of your estimated taxes is an income tax at both the state and federal levels. Federal income tax rates changed in 2018 and currently range from 10% to 37% depending on your income level. Knowing where you fall on the tax tier spectrum is an important aspect of your future financial planning.
State income taxes cover a wide range of rates and structures. Eight states use a flat tax rate, which means it’s the same for everyone regardless of income. Thirty-five states implement a progressive tax based on income brackets. If you’re lucky enough to live or incorporate in Wyoming, Washington, Texas, South Dakota, Nevada, Florida, or Alaska, you don’t have to pay any income tax at all, which is quite a boon come tax time.
A Simple Example for Paying Estimated Taxes
If you aren’t exactly sure how much you’ll earn in a year or how much tax to estimate, don’t worry. Follow these steps to ensure you get close to the amount owed each quarter:
- Take your first quarter’s income and multiply it by four to get your annual income
- Take out your self-employment tax and income tax as determined by your estimates
- Add these two numbers together to get your total tax liability
- For example, if your permanent U.S. address is in Illinois, your tax would look like this based on estimated earnings of $38,700 a year:
- Self employment tax = $38,700 X 15.3% = $5,921.10
- Federal Income Tax = $9,700 X 10% + ($38,700-$9,701) X 12% = ($970)+($3,479.88) = $4,449.88
- State Income Tax (Illinois in this case, which has a 4.95% flat income tax) = $38,700 X 4.95% = $1,915.65
(Note: The federal income tax rate is determined on a tier-by-tier level. So, although you made $38,700, you pay 10% on the first $9,525 and 12% on the amount between $9,701 and $38,700.)
From this example, you’d end up paying $12,286.63, or $3,071.65 a quarter. That seems like a ton to pay in taxes, and it is. But this is an overestimate of what you’d pay after the standard deduction ($12,200) and the self-employment deduction (½ of your calculated self-employment tax). Plus, you can further reduce these taxes through write-offs and deductions.
Write-offs and Deductions
Before you cut a check for $3,071.65 each quarter, make sure you take full advantage of write-offs and deductions as part of the debt side of your financial planning. Some of the most popular deductions for digital nomads include:
- Self-employment tax deduction. You pay 15.3% self-employment tax, but the government allows you to deduct half of that from your taxes (7.65%).
- Educational expenses. Are you taking online classes while you’re abroad? That’s good news, as you can write-off $2,000 via the Lifetime Learning Credit.
- Self-employed medical insurance. If you’re self-employed and have to pay for your own health insurance, you can deduct the entire amount off your taxes.
- Home-office deduction. This deduction allows you to write-off a portion of your home office, phone bills, internet bills, and anything that’s used for your business.
- Business expenses. Anything you purchase to help you complete your work is tax-deductible.
- Retirement deductions. A solo 401(k) and a traditional IRA (individual retirement account) are both tax-deductible.
These are just some of the deductions you can claim that can significantly reduce your tax liability. If you find it confusing, don’t hesitate to enlist the help of a tax professional to guide you through the process.
Foreign Earned Income Exclusion
Another amazing opportunity to reduce your tax bill is through the Foreign Earned Income Exclusion (FEIE). If you lived away from the U.S. for up to 330 days out of the year (known as the physical presence test), you could be eligible to avoid income tax up to the first $100,000 earned. You still have to pay self-employment tax, but the savings from the FEIE can be significant.
Paying taxes quarterly and taking advantage of deductions are two significant ways to reduce or eliminate a shocking tax bill at the end of the year.
Financial Planning for Retirement
As a digital nomad, you probably don’t have an employer-matched 401(k) or any other type of retirement plan. Therefore, it’s up to you to sock away funds for retirement. While savings accounts can net you a small amount of interest, there’s still a temptation to pull money out, especially if you’re on a trip.
That’s what makes a solo 401(k), a SEP IRA (simplified employee pension), or a traditional IRA so enticing. These tax-deductible funds allow you to grow your savings while reducing your tax bill each year. Each of them has its benefits, almost entirely depending on your income level:
- Traditional IRA: This individual retirement account allows you to contribute up to $5,500 a year, with every dime tax-deductible.
- Solo 401(k): This 401(k) is similar to the one you’d have with an employer, allowing you to put up to $18,500 into the account each year.
- SEP IRA: An oldie but a goodie, this was the original IRA for the self-employed. It functions as a tax-deductible pension fund for any employees you have, but it also allows you to take advantage. Contribute up to $55,000 a year or 25% of your income to maximize your tax deduction.
These are just a few of the options you have regarding retirement funds, but one of the greatest aspects is that you can’t pull money out without a penalty. If you dip into your savings account regularly, the 10% penalty can keep you from spending frivolously.
Combine these retirement accounts with more liquid assets, such as a savings account, stocks, mutual funds, bonds, or certificates of deposit for a diversified and successful retirement approach.
Budgeting
When you’re looking for your next adventure abroad, budgeting may not cross your mind. Yet it’s an integral part of financial success as a digital nomad. Before you start a budget, decide what lifestyle you want to lead.
Are you comfortable with bumming it in a hostel dorm room, or do you want a 20th-floor apartment with a balcony and view? Is it good enough to fly economy, or are you a glutton for first-class luxury? Do you love sitting in the front row of sporting events or concerts, or are you perfectly content with just attending? Only you know the answers to these questions, and being honest with your answers can help you accurately estimate your expenses and the income you will need to support your lifestyle.
First, you’ll need to estimate how much you make a month. From there, deduct your living expenses, such as rent, utilities, phone, groceries, and any other day-to-day expenses. Next, put together a travel budget that approximates the amount you’re willing to spend on flights and hotel rooms. Add in your retirement income and savings to your expenses, and you’ll find just how much you’re going to spend on a month.
Exact figures are difficult to determine, as expenses and income are highly dependent on your location’s cost of living and your revenue stream. Living in Southeast Asia will save you thousands over an apartment in New York City, but you may also have more opportunities to network with clients in major cities or economic hubs. Therefore, it’s up to you to find the balance that works for you.
Keeping an Emergency Fund
Medical situations, accidents, and natural disasters can happen with little notice. That’s why you should have an emergency fund at all times. The percentage of your income that goes into this fund can vary, but shooting for about 10% of your annual income should give you enough money to get home or to a nearby country with the facilities you need.
That said, you can also write-off medical insurance and travel insurance as an end-of-year expense. Make certain that one of these insurances has a medical evacuation (medevac) clause. Most medevac policies can transport you to a country with better healthcare if you happen to be injured in a developing country or one with limited access to hospitals and doctors. Oftentimes, this can cost $500,000 to $1 million without a policy.
Learning How to Do Things on Your Own
Learning how to do things on your own could be the best decision you make as a digital nomad. If you’re used to ordering in, eating out, or hiring people to do every small aspect of your life, now’s the time to do it on your own. Things you should learn how to do include:
- Laundry
- Cooking
- Cleaning
- Sewing
- Taxes
- Car/Bicycle/Motorbike maintenance
These are just a handful of things that can save you thousands of dollars a year if you take care of them on your own. Not only will you save money, but you’ll learn a skill that will last a lifetime.
Investing in Your Business and Yourself
With the digital nomad lifestyle becoming popular around the world, it’s important to stay on top of advancements in your industry. Investing in classes and seminars or attending industry conventions adds to your skill set, while also facilitating networking opportunities in your field.
You should also make sure you have the best equipment possible to facilitate and streamline your work. Don’t work on a slow, bulky computer when you need to edit photos or videos. On the flip side, don’t spend thousands when a few hundred bucks will do. It’s all about balance. In some instances, you’re only as productive as your equipment or training allows, so even if you feel like you’re splurging, remember that it’s an investment. Plus, it’s tax-deductible.
There’s no one-size-fits-all solution to financial planning as a digital nomad. You have your own tastes, income bracket, and lifestyle choices that impact every aspect of your financial well-being. Your financial plan is also a living, breathing set of ideas that need constant tweaks and reviews to remain practical. But no matter what you do or where you go, a healthy financial plan will reap benefits well down the road. Enjoy the ride.
Are you a digital nomad looking to learn more about financial planning? Which pieces of advice most resonated for you? Connect with Virtual Vocations on Facebook, Twitter, and LinkedIn to tell us what you think. We’d love to hear from you!
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