Taxes. Oh taxes how I loathe you. Last year in 2016 for 2015’s tax year, you got the best of me and received a nice check at the last day possible. After that moment in Mid-April of 2016, I did not want to go down that path again. I therefore, did y researched, spent time soul-searching for days, weeks and months to come to a plan. Finally, I will say this – I believe this year I kicked Uncle Sam’s ass, and I will show you how!
2015 Tax Year
To break down how this started even further, the year of 2015 had a few unique perspectives. I did not maximize my 401k nor was I doing this pre-tax, shame on me – as I am now a FULL believe of pre-tax investments. Additionally, I had over a 4 digit capital gain – some short and some long-term, which didn’t help my position, at all. Let’s just say, that my overall tax percentage was 14.74%. I know some may think that’s a little, but even after employer withholdings, these other items led to an increase in the $ amount of taxes that I owed at the end of it all.
Now, I am all about paying taxes when/where & how much that is necessary, but if I have to pay even more than what I had planned or projected – that doesn’t sit well with me! Further, that event of paying more tax at the end ate into some capital that I could have used for an investment! Here is a snip from my personal tax return to show you the percentage I paid and that I’m being very open here:
2016 Tax Year – 3 Rounds with Uncle Sam
So Uncle Sam had won round one. However, they don’t call me the Italian Stallion for nothing (sorry Rocky, had to do it!). I got back up, dusted myself off and said “BRING IT” in 2016. I read many sites, articles, the IRS website, the 1040 form, etc.. I did this because I wanted to understand everything that I could do given the expected situation that I would be in. I wanted to maximize wealth on this pursuit to financial freedom, increase my income producing assets – i.e. primarily dividend stocks, and reduce my expenses as much as possible – which taxes is a HUGE Part – see why I aim to save at least 60% of my income each month.
All of this research, soul-searching and discovery let me to employ 3 things as much as I could have in 2016. Here are those items that I had altered/took on/or went max:
Round 1.) I went from a Roth 401k up to my employer’s match to change to a Pre-Tax 401k and MAXIMIZED this as much as I could. However, I could not do the full $18,000, as I had already had amounts taken out for the Roth 401k at the time of switching, but I was able to have over $16.4K go pre-tax into the 401k. This alone, saved over $4,100 in federal taxes! I did this maximizing within the last 4 months. See why I chose to max out my 401k.
Round 2.) Health Savings Account – Not only did I max out my 401k pre-tax to the best of my ability, but in the short time frame I maxed out my Health Savings Account (HSA) in that short duration as well! This was $2,900 in contributions that I was able to do, as my employer contributes $500 every year, which saved me another $725 in federal taxes, that’s what I’m talking about.
Round 3.) Traditional IRA – Yes, the tri-fecta here. As an employee making most of your income via wages, there aren’t too many other things you can do outside of those listed above. However, those two items listed above, if you are fortunate – can reduce your modified adjusted gross income low enough that you may be able to contribute all or some funds into the traditional IRA account, which is then reflected as pre-tax on your return. I used to maximize my Roth IRA each and every year – and not like that’s a bad thing – however, I wanted to take Uncle Sam DOWN and keep him out for the count for 2016. Therefore, based on my thresholds, I contributed $3,379 to the traditional IRA. This saved me roughly another $845 in federal taxes.
Based on those three moves, I was able to reduce the federal tax expense by ~$5,670. How do you like that Uncle Sam?! That’s right, I hear crickets! However, what did that mean on my overall % that was paid or my effective tax rate… well… I reduced it to 10.34%! Here is the snip, as filed:
Tax & Uncle Sam Conclusion
In conclusion – this is about getting better, understanding what one can do with pre-tax investments and building wealth. All of this additionally increased my forward looking income quite a bit in 2016, as well, as they are investments within Vanguard overall market funds that produce quarterly dividends. What I’m also trying to say is – you should work hard at keeping every dollar that you make, every single fricken dollar. I cannot stress that enough – every single dollar counts! For tax savings – those extra funds can be applied in a drastic number of ways – fueling investment accounts, paying down your auto loan, your mortgage, increase your savings, money down on a rental property – you gosh damn can name it! For a basketball player to work hard for you on your team – think they will do it just because? I don’t think so. You need to work hard to keep, maintain and develop that – in order for “that” to work hard for you in return.
Overall – I went toe to toe with Uncle Sam this year and had the three knockout punches to take him down. There is a lot of noise, at the moment, from Donald Trump in regards to potentially removing the 401k tax breaks. Does he want to urge individuals to save or not? I know if this happens, I will stop, no doubt, so that is a curveball in the mix, for sure – so please keep that all in mind everyone, as these circumstances have a chance of being modified and/or changed. However, I am investing today, based on what is fact and not based on the “what-if” scenarios. We shall see what improvements, if any, I can make to my 2017 tax situation, but I found it to be a very fun challenge in 2016 to take on the bout and come out a winner on the other side. I was able to have more money invested/saved and I even had a refund to boot at the end of it, due to this opening up further tax-advantaged situations, like the traditional IRA.
What does everyone think? Employing any of the strategies above? Any questions relating to it that I could help answer? Any holdbacks from doing this? Would love to hear your stories and if you also won a battle with taxes!
-Lanny