The author has 3 children, and that's a _household_ income of $150000. 150 grand is not a huge family income to support 2 adults and 3 kids; as a country, we give people tax breaks to encourage having children and to help support people who make that choice.
Calling this "Houdini-like" (author's words) tax hacking seems like a bit of a misunderstanding of deliberate social policy!
Yes, and an awful lot of families in Africa and Southeast Asia are doing this on 1/150th that amount. With more kids. Your point?
The existence of more extreme poverty doesn’t change the fact that 150k/yr is not a ton of money to support a family of 5 in most American metro areas.
Small point, but the average household size in the US is 2.5, on half of the 5 people in this household, so you really can't compare their family income to family income statistics for much smaller families.https://www.statista.com/statistics/183648/average-size-of-h...
I think this will become a pedantic argument, but without defining loophole, we can’t say they exist or don’t.
Presumably a law is written with some intent.
When that intent or spirit is broken because of poor construction or poor foresight in the text of a law, a lot of people call that a loophole. I think it is a fair definition.
Childcare for 2 children under the age of 5 in my area will cost roughly $4000. Mortgage for a very modest 4 bedroom house is another $2500. $1500 for all the rest starts to get very tight. Insurance as a category alone can eat half of that. There’s not much left to gamble or drug with.
The two biggest reducers he cites are 401k contributions and tax-loss harvesting.
#1. 401k.
While this is a great idea, if he's trying to retire at 33, putting 17.5k away from his 70k paycheck is not going to help because he can't touch it until he is 59.5 (w/o penalty).
#2. Capital losses
Tax-loss harvesting means selling securities that are underwater to get a capital-loss deduction. I don't know where to start explaining why this is such a bad idea. I'll pick the two most compelling reasons why this is dumb. First, you can only do this so many times before you've whittled your investment to zero. Second, you are violating the most basic principle of standard-person (non-rich) investing: buy and hold.
>because he can't touch it until he is 59.5 (w/o penalty).
That's not quite true. With 5 years of preplanning, you can get money out of a 401k without any penalty at any age (although, you will of course pay taxes on it) by doing a backdoor Roth IRA ladder.
Adding onto this, this article compares various approaches to getting money “early” out of a 401k/tIRA (Roth conversion ladder as said here, 72t SEPP’s, early withdrawal penalty), and has the surprising conclusion that even the “just pay the 10% penalty” comes out ahead of regular taxable contributions, at least in some situations.
I've not heard of that. So it goes from one IRA into another? Why? Plus, ROTHs have yearly limits of $6k. While it can be done I don't see the benefit of doing it, esp. given the tiny amounts (compared to what is needed for retirement).
You can rollover 401k money into a Roth IRA (but this is a taxable event and you will pay income tax on that - just a note because "Roth" in the name tricks people up). That money will count as a contribution (ie not a gain). There's also NO limit on how much you can convert.
You can withdraw any amount of contributions to Roth IRAs no penalty. But you have to wait 5 years for rollovers.
So basically
1. Pick how much money you'll need in 5 years
2. Rollover that much money from your 401k to a Roth IRA (pay taxes in this step)
3. 5 years later withdraw that money from your Roth IRA
Step two is a big deal. In fact, its kind of a headscratcher. You have to believe you can earn back the lost capital from taxation in your investment horizon for the tax free benefits of the Roth IRA to make sense. Tough computation to make. Or am I missing another benefit?
I think you're confused. 401k withdrawals are always taxed, even when you're over the age limit. The tax advantage is that you aren't taxed on the way in.
The benefit is that you don't get hit with the additional 10% penalty for early withdrawal from a 401k. The Roth IRA is irrelevant; it's just a vehicle for you get money out of the 401k without the penalty.
You'd do this as you enter early retirement - like with a normal 401k withdrawal, in this hypothetical your tax bracket will be far lower in early retirement (and not working) as you withdraw.
Basically, by doing the backdoor Roth ladder you get to pretend there's no penalty on withdrawing early. No penalty. Yes, you still get taxed.
Ah. Good point. It is not a penalty, it is just the tax all at once that you would normally pay over the life of the distribution. Unless that tax isn't capital gains and pushes you into a higher tax bracket, as opposed to a lower tax bracket if you had withdrawn over time in smaller quantities. I don't know if IRA dispursions are taxed as capital gains or income tax.
>it is just the tax all at once that you would normally pay over the life of the distribution.
It's not. You don't have to rollover the ENTIRE account. You can choose to only rollover a certain amount of money.
The idea is say, you calculate that as a person you spend, say, $60k a year. So 5 years ago, you convert $80k of your 401k into a Roth IRA. It becomes ~$60k after being taxed. Your tax bracket is just the one that's an income of 80k would be at, because you only converted 80k.
Now you can take that 60k and spend it on your life. Repeat every year, that's the ladder part, and you can spend money out of your 401k no penalty, normal tax rate, as if you were retirement age.
No, you're doing it because you can withdraw contributions from a Roth IRA with no penalty. The Roth IRA merely exists as a vehicle to get money out of a 401k with no penalty.
In this situation, there is no difference from if you were actually retirement age and withdrawing from your 401k. Same taxes, no penalty.
Hey just wanted to say thanks for explaining that. I had a talk with my RIA and he never suggested it because my position for the past decade of working with him has consistently been that I would be working past IRA penalty age so it wasn't an issue. But we are considering it for other reasons now that I know it exists (e.g., early retirement).
You're always going to pay taxes on 401k, even if you wait. The point is to contribute to it tax free while you're still working and have a high personal income.
You do the Roth ladder when you've going into early retirement - your personal income will be low because you're no longer actively working.
And because taxes are progressive you are minimizing taxes.
Most tax-loss harvesting strategies incorporate a re-buy of a similarly-performing but substantially different asset. Of course, selling an asset just to maximize tax losses is unwise, but in the context of diversifying your portfolio, tax loss harvesting has its place.
Say you own VTI, a total US market etf. Then the stock market drops 20% next week.
You can sell VTI and with the proceeds immediately buy VOO (s&p500 etf) within seconds.
VOO and VTI are insanely correlated, so you’ve basically triggered a 20% loss for tax purposes, without actually selling any of your exposure.
That said, it’s not as big of a value as you might think, since you’ve also stepped down your basis, and need to pay more capital gains taxes when you sell since you “bought” at a lower price now.
Generally accepted wisdom is to TLH up to the yearly loss deduction amount (like 3k or so) and stop.
The suggestion in the link was to sell investments that are underwater and replace them with similar assets, in order to remain invested. Not similar enough to be considered a wash sale, though.
It's not strictly speaking incompatible with buy-and-hold, from my perspective. I'm not an expert though, I don't even live in the U.S.
This is for a couple with kids, so both can max-out 401(k)s, IRAs are still a thing wen you make <$124k, so they could make out both, and because of the kids, you can use pre-tax money for dependent care, and there are tax credits for kids.
The other giant caveat is they merely deferred taxes on $46,000.
For any of our friends outside the US, this is not normal. As someone with a similar income (single - not married couple) but 0 children, 0 "special" government deductions, etc, here's a breakdown of my 2020 numbers:
- Income from employer: $168K
- Investment income: $41K
- Total income: $209K
Deductions (rounded numbers):
- $19.5K (private retirement 401k)
- $12.5K standard deduction
- $3.5K health care savings
- $3K MEME stonks losses :(
Approximate taxable income after deductions: $170K
Taxes paid:
- Federal Income tax: $32K
- Federal Social security (gov't pension / disability insurance): $8500
- Federal Medicare (gov't old age health care): $2500
- State Taxes: $10K
Total taxes: $53K
So I'm looking at about 25% taxes due. Also, my employer had to match my federal Social Security and Medicare (which is essentially taken out of my pay), so it's closer to about 31%.
That's certainly better than what (it sounds like) you guys pay over in the UK, EU, etc, especially as my salary over there would be taxed in one of the higher brackets, while in the US, I'm in the "middle", though I have very few deductions that larger families will have (especially if they own a very big house in an expensive state).
In high tax states like California, you would add another 4-5% or so - you'd end up at 35%.
In the UK, I calculated I paid roughly 22% on a similar employee salary by putting enough money in pension contributions (+ employer match and government match).
I also have a limited company where I do occasional work (without having to increase my income taxed at 40%) and that I use to draw dividends from (up to free allowance) yearly and get some other advantages, which was a decent way to get extra untaxed income. These days the allowance is 2k so there is not much to get.
The disadvantage of using a pension is that I won't get that money until I'm 60 (and they keep increasing the age where you can withdraw money). I'm kinda forced to do that and maximise
I'd rather invest the money in buy-to-lets than the weird ETF a pension is, but then I would lose 40% of my money to the government.
Being employed in the UK is not very convenient over 50-70k (and it becomes especially painful at 100-120). You are always better as a contractor outside of IR35 with your own limited company, unless some of the benefits make it worth it (eg. long paid m/paternity leave, stock options you really care about).
Unfortunately being outside IR35 is getting more complicated, corporate tax rate is increasing and buy-to-lets lost some of the tax advantages they had.
Overall if I had to pick a country with bad weather to make money in, I'd go with Switzerland instead of the UK.
Tbf your income is also very not normal. The article is a much more typically family income - their combined income is still less than your individual income by 50k! Because they are two people, they’re doubling up on things like the 401k deduction.
You make far, far more than them.
The “average” American would be able to get pretty close to what the article is doing.
But probably shouldn’t and won’t because you can also see they’re leaving a pitiful amount for themselves to live on in the moment.
on $209k salary or £148k, here in UK the total tax is £46,632 and £6,838 for National Insurance. So about 36% which is almost the same as California. Source: https://www.thesalarycalculator.co.uk/salary.php
I... usually hear this sentence sarcastically... but here it really seems as if the author isn't using it as such. I dunno, if you're a proponent of Starve The Beast [0], this is a consistent belief I suppose.
Holy shit, $500 a year for health insurance? I pay twice that a month and don't even get an HSA option.
Seems weird to put so much into retirement funds if your plan is to retire in your 30s, the penalties of touching that before 60 are pretty substantial.
I suspect there's some sort of inheritance of property or something they're not disclosing.
No, It's $500 + $6,450 so $580 a month plus an unspecified employer contribution. Because it is a HDHP with an HSA though they are incentivized to keep their costs in check and anything they don't spend of the $6k gets rolled over to the next year and once you hit retirement if you have a surplus at retirement age you can use the money like an IRA.
HSA has nothing to do with the quality of the insurance plan btw. HSAs are only available in conjunction with HDHP (High Deductible Health Plan). Typically, HDHPs are Bronze level plans that don’t provide a good coverage (which is why HSAs are allowed to supplement such plans).
Good on the author for making use of these tax benefits. I don't see anything out of the ordinary here. For govt workers, the 457 benefit seems really nice. Having kids in an LCOL area seems to be very doable. I imagine the same article but for 10x the income would be "interesting".
As a side note, it's worth indicating that if you work at FAANGs and other types of companies, you can use the mega backdoor Roth IRA method [1] to put up to $38k away in retirement accounts a year.
I used to follow their blog and they are at the forefront of the FIRE movement. No thanks. It's crazy the length they go to in order to minimize their expense. They def have a lot of help from their family. It def is click bait and what they're doing isn't "healthy" in my opinion. We let our kids be kids and that means spoiling them on many things. I'm not referring to iPhones or cars, but more like I'm not going to worry about whether I should buy two icees or one icee to split between both kids.
I’m always amazed that people think 401(k)s are a great idea. Yeah, that’s exactly what I want, the government telling me how I can spend my money, until I’m almost ready to die, with no guarantee the laws governing 401(k)s won’t change along the way, or that some moron politician won’t siphon from my retirement.
401(k)s are privately managed. They were originally designed as a technique to replace pensions, and are separate from government-mandated savings like Social Security. How would a politician siphon from your retirement? A 401(k) is basically just an IRA that a company manages for you and pays someone to administer so that the deferred tax burden can happen. Or do you mean that in the future, taxes may go up? If that’s your belief, nothing prevents you from using a Roth 401(k) if your company offers it (my previous 2 employers both offered this).
There's actually nothing in the United States Code that specifies whether or not "Cash or deferred arrangements" (U.S. Code § 401, subsection (k), or "401(k)"), is privately managed. A 401(k) can be a publicly managed pension! A 401(k) is a type of pension. A 401(k) agreement can straight up be cash payments!
> (A) [...] a covered employee may elect to have the employer make payments as contributions to a trust under the plan on behalf of the employee, or to the employee directly in cash;
It's just that no one does that. That trust that is mentioned is the stock portfolio approach that nearly every organization uses.
> How would a politician siphon from your retirement?
I guess you weren't listening to political discourse for the last 8 years, you know, where politicians repeatedly suggested that we add additional taxes specifically to 401(k) trusts, annually, as another form of expense ratio.
They are just deferring taxes. Taxes will be paid anyway in the future.
In some ways I prefer to pay taxes now because you are free with your money and that is wealth in itself. A new crazy Bernie comes and changes the rules and you are f*ck$d with 30-40% of your savings disappearing in days by inflation, formal currency devaluation, new taxes and so on.
E.g If I were living in Peru today I will fly with my money as soon as possible with the new communistic guy in charge. Just hearing him talk in the past would be enough to take the decision.
Yup.. you don't really start to get hit by federal taxes bad until after that 150k mark. You'd still be getting wrecked by property taxes or rent and sales tax in my state though.
Why? Tax brackets are progressive, so even if you had moved up a bracket it wouldn't change the fact you're still making more money (i.e., you don't suddenly go from paying 24% to 32%; you just pay 32% of the money made above the 24% bracket). And given the 2021 brackets, if you're single, you haven't even moved up a bracket ($86,376-$164,925 is the 24% bracket), but even if it had, your effective tax rate barely changes.
About the only thing you lose moving up in income is the ability to contribute to an IRA, and, of course, being able to claim various benefits that you aren't eligible for if you've been in 6 figures anyway.
But realistically for me the only change is I’ll owe instead of getting a refund on account of the withholding. Considering I don’t keep much in cash I’ll need to make some changes in a year.
Why will you owe instead of getting a refund? What has changed this year? Are you a 1099 and you didn't contribute enough? Because if you're a W2, and you haven't changed any of your amount withheld, you're just making more, and you got a refund last year, and it's the same employer...I'd be shocked if you ended up owing.
Even if you changed employers, it's unlikely you'll end up owing (at least, not much); while the new employer won't know what bracket to start withholding from, the extra amount you'll be paying into social security is an extra 6% that will likely cover much of it.
That's not true, you can always backdoor Roth IRA. And if you have a 401k and depending on how it works you might be able to do a mega backdoor Roth IRA.
The best tax optimization trick you can do is to open an LLC.
Costs $800/year to maintain in California, enables you to claim business expenses for a looot of things. Sometimes surprisingly.
You don’t even need a whole lot of revenue. Just sell something, anything, and go for it.
The penalty for going overboard is to pay back taxes with a bit of interest. As long as you don’t do anything crazy, you should be fine.
Remember: USA uses taxes to encourage you to spend money on approved activities. Like running a business, having kids, or buying your primary residence.
Yeah, for anyone reading who needs to read this: don’t do this. Unless you’re running a legitimate business, this is blatant tax fraud.
Also $800/yr in California? You people are being ripped off. LLCs aren’t laid any fees to maintain annually in Arizona, and they’re perpetual entities.
Definitely not tax fraud. You’re allowed yo be bad at business if you can afford it.
Afaik you are “running a legitimate business” as soon as you’re selling stuff. Even if it’s github sponsorships for your opensource projects or whatever.
Fraud is what most people (probably) do — not report that income on your taxes.
You can’t just form an LLC and start writing off your home furnishings as a “business expense” because you make $5 a month from a browser extension that some people donate to your Paypal account.
That’s tax fraud. That’s literally what that is. It’s incredible that anyone would think otherwise.
Claiming a home office which you do not use exclusively for business purposes as a business expense is tax fraud. If you have a fake "business" which you spend an hour a month on then this is only useful if you have an extra room in your house that you're fine with effectively just boarding up.
Nope, it’s really neither. It’s just straight up breaking the law. You’re not evading taxes because LLCs still pay them, and you’re not avoiding them because LLCs have limited taxation benefits.
I wonder if odds of that go up if you brag on the internet about your sort of shady approach to taxes and cavalier attitude that it's just some kind of game to be played.
Calling this "Houdini-like" (author's words) tax hacking seems like a bit of a misunderstanding of deliberate social policy!