Welcome back! After my first post, I am hoping things are heating up, especially due to over 12+ comments about strategy part one! I wanted a nice segway into this section, Part 2, on my trip to reduce taxes and invest MORE. This is possible everyone, VERY possible. The first portion of my strategy was to maximize my 401(k) with my employer, which will result, in this first year, a savings of OVER $5,000! However, as you guessed it, it does NOT end there.
The strategy, Continued
As I had begun in my first post on maximizing my 401(k) through my employer to save just over $5,000 in taxes, it leads to another portion of what more we can do. It leads to another avenue of investing, tax savings and building assets that produces cash flow for you. Is there more? What else could you do? Someone may ask. In my eyes, as with life itself, there is always something more that you can do.
Carried forward from that first post — > To begin, I 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. Looking back, I had over $37,000 invested (including dividends) from my two hands into the market, without considering part 1, this part and further portions of my strategy. If you strip out dividends received last year, I 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? Well, to reference portions of “The Strategy” (as I like to call it):
I will still provide a link to MadFIentist – as he shows the way on how to access these funds earlier – > LINK
This then introduces – Part 2…
Strategy 2 – Maximize Health Savings account (H.S.A.)
For starters – H.S.A. (Health Savings Account) is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan (HDHP). The funds contributed to an account are not subject to federal income tax at the time of deposit (Wiki). I know my current employer offers one and also, if you are single, contributes to my account at $500/year or $1,000/year for a family. The maximum amount you can contribute in 2016 is $3,350. Therefore, in my scenario – i can contribute $2,850.
For the first 6.5 months of being paid by my firm this year, I’ve had my account, but NEVER contributed to it this year. Well, that is changing and for the next 5.5 months – $259.09 will be coming from each one of my pays into the HSA account. But why? You may ask. Here are the reasons why I am going to maxout this account, as well:
1.) You can invest this into, for the majority of plans, into stocks/equities if you’d like. My plan is through BenefitWallet, which one of their investment options is Vanguards Total Stock Market Index Fund – I’m okay with that one. Also – has a 0.16% expense ratio, fairly low, with a quarterly dividend. The fees are $0 on the trades, which happen automatically each pay, with a $2.95 monthly charge. With a $500 employer contribution, that’s fine with me, for now
2.) These are tax-free from the following entities: Federal (25%), State (~2.5%), FICA (~7.65%), At, for this scenario, $2,850 – that’s a $1,001.78 total tax savings; not bad, eh?
3.) You can begin to use those assets when medical bills occur. You can choose to still pay with after tax dollars, but as long as you keep adequate documentation of what medical item occurred, you may be able to tap into the account then at any time. Also – with the investment growing tax-deferred, the balance more than likely will grow and it’s more than likely at some point throughout your life you’ll have medical expenses. Especially once you start having a family!
4.) Another investment tool one can have, taking advantage of free money from an employer, as well as being able to transact at a lower cost and protect those assets from taxation currently!
5.) You could argue – the tax savings from Maximizing out your pre-tax 401(k) can be used to fund this account, which further reduces your taxable income!
6.) Is another element, along with pre-tax 401(k) contributions, to reduce your Modified Adjusted Gross Income (MAGI). This will be VERY helpful in a future post.
There still could be a few disadvantages to having this account:
1.) You need to have a High Deductible Health Plan (HDHP). Which means your health insurance will not kick in until your deductible limit is reached, mostly for non-preventative care.
2.) Worst Case Scenario – you can’t touch the assets until 65 years old, if no medical history.
3.) The fees/costs may be high depending on what provider you would have to go through.
Breaking it down – real example
Okay, let’s say I do decide to make the $2,850 per year (typically is $3,350 but that is reduced due to employer contribution). What does that look like from a tax savings perspective from the first part and this part combined? Let’s use an example of someone who makes $71,750 for the year.
WOW. So you can see above – not considering any local tax impact, that if you maximized your pre-tax 401(k) and HSA – that you’d save almost $6,000 in taxes! I would have normally invested this anyway, and now this allows me to already invest almost an extra $500 more per month due to the structure of these investments. Absolutely loving it. Last year I invested $32,000, with after tax dollars. Instead, $20,850 of that $32,000 will be invested into pre-tax investments, thus I would have around $11,150 to invest. However, with the tax savings, I now can invest almost $17,150 still in my taxable accounts if I wanted or into other “retirement”/investment vehicles.
Similarly, here are questions that could occur:
What about the investment options with an HSA? It looks as though it is limited. Similar to Part 1 – you can’t beat the market in the long-term and if there’s a Vanguard investment option – it more than likely is low and holds a very solid/above average dividend growth rate, due to what their holdings are!
What if you want to access the HSA funds earlier? That is a good point to bring and if I don’t have any medical expenses it will cost me 20% in penalties + any taxes on gains at that point. This is probably the one area that may occur. BUT, we are also talking very little investment here, as well as the HIGHLY likelihood of receiving medical expenses, at some point.
With all of this being said – I am employing this strategy and automating more of my finances in a tax-advantaged way. I am eager to see what August will look like once this is all said and done, as that will be the first full month of this “package” taking place. Saving $6,000 from this strategy sounds awesome and using them to fuel financial freedom faster sounds even better.
With 2 parts of this strategy down… does it stop there? Hehe… well if you saw me talk about modified adjusted gross income (MAGI), then you bet your last dollar I’m not finished. Stay Tuned to… Part III aka TO BE CONTINUED….