Very strange article title, isn’t it? To begin, I love dividend stocks to invest in. I love the pursuit to financial freedom and to be completely independent in the decision of what to do with my time. As with that time – happiness is what truly matters, and making a difference in others lives. I want to do that, NOW, Tomorrow, the next day and so on. I want to be able to spend as much time with friends and family as I see fit in my life and to help others that are in need. In doing some “deep-thinking” on how to further expedite this, maximize my money, which buys time, I have changed a strategy of mine. The target? Taxes.
The Strategy
When thinking about everything, it lead to some immense thoughts and analyses. Bert can tell you the countless calls and my girlfriend may be sick of me by now with the debates and questions. There really are multiple approaches and items within this strategy, we can call it a 3-way or a 3-part strategy, with the focal point on taxes. Not just saving on taxes, but taxes with secret “back doors”, to make this more exciting. I mean, come on – who doesn’t want to reduce their tax burden while protecting assets? And who wouldn’t want to walk through “secret” or “back” doors. To begin, I already save approximately, at a minimum, over 60% of my income each and every month. Therefore, investing capital, luckily for me, has never been a huge problem. If we include dividends in 2015, I had over $37,000 invested with my two hands into the market. Even when excluding those dividends – still eclipsed almost $32,000 – to me, that’s a fricken ton of money! Now what if, WHAT IF, I could have more funds at my disposal without negotiating my salary or shaving any further of my living expenses? We all know that I believe, wholeheartedly, in the concept of every dollar counts, and this is no different. Taxes. The biggest expense I have, Uncle Sam’s taxes. We all know about my struggles during the first 4 months this year, having some big tax payments in April to make (let’s say over $2K I owed). I looked back at 2015, and I paid a whopping $19,046 in state/local/federal taxes! This doesn’t even include FICA, Property or other form of taxation throughout the year. How amazing is that? Well, I guess not too amazing, since that’s almost $2K per month gone, out the window. Now what could I do to reduce that, without reducing the money coming into the pocket? Insert – Strategy 1.
Strategy 1 – change to and maximize traditional 401k
Up through my first employer-pay of June 2016, I was invested into a Roth 401K at only 5% per pay, as my employer only matches a maximum of 50% of our first 5%. When I was growing up, in my college courses and any other “general” personal finance book or article talked about why we should all invest into any form of Roth if we can. I drank that koolaid for some time now, and don’t get me wrong – it is a GREAT vehicle and a great account to protect after tax-dollars, hands down. So of course, in my situation, with my “little” 5% contribution, I was paying with post-tax dollars, all because I used to think Roth was the sheer one and only true way to go, that if you did the traditional pre-tax 401k route, that you were out of your mind! Well, I no longer think that, at all. This is especially after reading about different conversions you can do, ladder step-ins with the traditional to a Roth, i.e. the backdoors. The reality clubbed me smack in the face with how much you can save – with heavy thanks to Madfientist articles (whom I HIGHLY recommend if you want to get down to pure numbers and strategies). It is amazing to find out that there are backdoor strategies to legally convert Traditional 401k funds to a traditional IRA and then from there to a Roth IRA, it takes dedication and time to perform this strategy but I highly recommend readying THIS ARTICLE to help build the case.
To lay retirement facts – for 2016 the maximum you can contribute to a 401k with an employer sponsored plan is $18,000. Now, since I have contributed through 5.5 months worth of a Roth 401k, I won’t be able to do a full traditional-401k at $18,000; but somewhere in the mid $16K range.
I have decided to switch and have had my last pay in June and first pay in July already as Traditional 401K contributions (pre-tax). By adding $16,500 (for easy math), this will save at my 25% federal bracken, 3.5% local tax and approximately 2.5% state tax a total of $5,032.50 in taxes (below). Most may use this money to fund a new car, home theater, swimming pool, or pay down other things. I am going to INVEST this. Why? Because EVERY DOLLAR MATTERS!
So what just happened? I invested, what I normally do regardless, into a pre-tax 401K and it gave me an extra $419 per month to invest in. I normally would have only contributed a minimal ~$3.75k into an IRA and I just sprung to $18K, pretty intense. How’s that? Think that’s pretty cool? I know, I know – the comments of:
“But.. you can’t touch that before 59.5 or you’d face penalties beforehand, and you have to pay taxes on all gains and growth” – there are ways to suppress any damage if you need to access this early, which MadFIentist kindly explains. Reference his article above. We can all convert because we are all going for financial freedom. Our taxable income is going to be so low, that you can transfer/convert, slowly, funds from one account to another, with little-to-no taxation or penalties. But it takes HARD planning to do this.
“But you are limited only to investments that your employer offers in your plan.” – This is VERY true. I love dividend stock investing. Guess what? I’m not stopping, and based on last year – I can more than likely still do $14K on top of $18K oh and let’s throw in another $5K in tax savings, so do not expect to have an immense slowdown, at all, into my dividend investing endeavors! In fact, this improves the overall investment.
“But still, you have more funds going into a mutual fund” – my investment is Vanguard Institutional Index (VINIX) – a low as heck expense ratio. Newsflash investors – It is very, VERY difficult to beat the market consistently for a long period of time. I’m not saying I can’t (Cocky, I know), but the VINIX investment is not a BAD option – the growth rate is great, yield is at or above the S&P and they pay quarterly, I’m “Cool” with that.
“What about the yield? It is roughly between 2.25-2.50% on the fund, where you can invest and receive 3.5-5% on stocks” – This is true. However, I am capturing the entire market and the growth rate of the dividend on this is right where you want it to be 7%+ for a very, very long time. I expect this to continue, therefore, in time it comes out “just right” with a growth rate over my entire portfolio and combination dividend impact of close to 10%+ I think I can say again, I’m “Cool” with that.
It doesn’t stop there… there is another strategy and impact from this first one and that is…. —> (To Be Continued… See Part 2 here)