Welcome back! After the first two posts, I can see now the heat coming from the articles and the insight that individuals are also providing through their comments. We all want to save on taxes, reduce the liability, invest more money and keep more of that money, which we earn through our sources of income. Here we are… Part 3 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 and the second portion of the strategy led to tax savings of over $1,000 MORE! 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):
Part 1 – Maximize your Pre-Tax 401(k)
Carried forward from the second post –> 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. On top of this – I will save over $1,000 by maxing out the health savings account!.
How? See my link below for part two of my strategy:
Part 2 – Maximize your Health Savings Account (HSA)
I will still provide a link to MadFIentist – as he shows the way on how to access these funds earlier – > LINK
Strategy 3 – Maximize or contribute to traditional ira
Now that saving over $6,000 was discussed from the two articles above, we will talk about what more you can do. This will be strategy 3 or part 3 to save more in taxes, so that you can invest more. We will talk about the best case scenario and my real-life scenario.
So there is the individual IRA account that you can also establish. Now – what TYPE of account you can invest in depends on your Modified Adjusted Gross Income (MAGI), as there are different thresholds that could prohibit you to invest into one or the other, or both account types. There are two account types – Traditional IRA and a Roth IRA. It becomes less likely to not be prohibited form investing into a Roth IRA, but please resort to IRS websites for this information and more likely if you have a moderate income to be prohibited to invest into the Traditional IRA. The difference between the two accounts are one is deductible from taxation – the traditional IRA (you can deduct your contributions from reported income), and one is non-deductible, the Roth IRA (aka, you pay with after taxed-dollars). Additionally, if you are under 50, you can contribute $5,500 for the 2016 year into one/combination of the two accounts, and over 50 – that limit increases to $6,500.
What does this mean? Well, as I said, we will go over two scenarios – the picture perfect scenario, where you can invest the full $5,500 into a traditional IRA vs. my scenario. The picture perfect scenario will kick start us:
You are able to invest $5,500 into a traditional IRA. After maximizing your 401(K) and your Health Savings Account (HSA), your MAGI was just reduced by $20,850 ($18,000 for 401(k) and $2,850 for HSA as the employer kicked in $500) and you are able to be within the threshold to maximize your traditional IRA. If you invest the $5,500 into the traditional IRA, here would be your tax savings using a 25% federal and 2.5% state tax rate (rough average):
That is a whopping $1,512.50!!!! Now… let’s combine what we did in part 1 and part 2, to really bring it to life. This chart will be similar to the chart that I placed in the part 2 of the strategy:
DAYUM! Total to be saved in this normal perfect scenario is $7,464.28 when you combine all 3 strategies into one. That is an extra $622 to invest in, on a per month basis. So here you are, investing $26,350 already in pre-tax dollars, which then allows you to invest an additional $7,464 into the market, for a total of $33,814. Holy smokes. Since I already invested that much with after-tax dollars, this would essentially bring me closer to $40,000 invested in a single fricken year! It is insane. As a status check, with dividends reinvested, I have invested $21.2K into the market through the 10th of August. With implementing the bulk of these strategies, I’ll be cruising over $40K.
My situation. My situation is a tad different, as I won’t experience the full tax benefits laid out above. Why? I know I talked a little bit about this in the first article, but in the first part of the year – I contributed a few thousand to a Roth IRA already (Yes I could always pull the contributions out and re-direct, but don’t feel like making a few transactions), and had invested into my Roth 401(k) for a portion of the year. Therefore, my tax savings will be roughly $6,625 in the first year of deployment of my strategy. It’s not the full benefit, but hey – that’s over $550 extra per month for me to invest!
How do you access these funds earlier than what is required or mandated via the IRS? Definitely read Madfientist’s article located HERE. As this article describes the systematic approach to doing so, based on the tax code today. Reading his article has been one of the best things I’ve done, hands down.
Conclusion on the tax strategies
With all of this being said, now that we are three articles down – how does everyone feel? If you invest into a Traditional IRA and are in the 25% tax bracket – you can save a load of money here. Further – I used a conservative tax rate of 2.5% for state, where based on my income level – I actually pay 3.465%, so my tax savings are even higher and I am sure you can too. There are ways and methods in accessing the funds earlier, as well, as I have linked above. Here is what I also have truly realized. Saving and investing is amazing. The methods for tax strategy that we choose to perform are our own decisions and is definitely based on what works with you in your situation. We are all doing the most important thing when we read these articles and consider them – and that is the pinnacle of the path to financial freedom – SAVING & INVESTING. No matter what we are making great decisions, and that’s what I truly want to say. In my situation, I believe I can use these strategies to be financially free, smarter and potentially faster. This will continue to evolve, I am sure, as tax rates, brackets, maximized amounts, etc., will all change with time. And guess what? I am looking forward to it all.
Thank you everyone for reading. Please share your thoughts, conclusions and assessment from the items listed above and in previous articles. I cannot wait to read them and have deep discussions on the pros/cons and methods of the strategies listed. Keep on saving and stay consistent with investing everyone! We are all doing great and God bless.
-Lanny