I hate paying taxes, and can be something of an ideological nut job when it comes to avoiding them.
In my younger days, before my wife dragged me kicking and screaming into normal, civilized behavior, I was known to subsist on rice and beans for a month or two at a time.
Back then, I did just about everything I could in order to free up cash to max out my 401(k) plan, Roth IRA, HSA plan and any other tax-free savings vehicle I could get my hands on.
Yes, it was Spartan. But it saved me a ton in taxes over the years, and I’m still enjoying those benefits years later.
Don’t worry, I’m not going to recommend you go to my ridiculous lengths. My pathological need to lower my tax bill is probably unhealthy, but with the tax return deadline coming up on Monday, I figure a little advice on prioritizing is in order.
It might be too late to put any of this into practice for your 2015 return. But you can absolutely make a dent in your 2016 tax bill. So, with no more ado, here are a few tips for lowering your tax bill this year.
It starts with the 401(k). Before you invest a single red cent in anything else, you should come as close as you reasonably can to maxing out your 401(k) plan.
In 2016, that maximum contribution level is $18,000. If you’re young, that might not be a realistic goal. For some recent graduates, $18,000 might very well amount to nearly half of their after-tax income.
But if maxing out the 401(k) isn’t doable, then you should at least contribute enough to take full advantage of your employer’s matching, which usually amounts to 3%-5% of your income.
If I had an employee under me that didn’t contribute at least enough to get full employer matching, I would find an excuse to fire them.
Employer matching is an instant, tax-free, 100% return. If you’re not smart enough to take advantage of instant 100% returns, you clearly don’t deserve your job.
Once you max out the 401(k) plan, look into contributing to a Roth IRA. A Traditional IRA usually isn’t tax deductible if you’re already contributing to a 401(k) plan, so a Roth is going to make more sense.
A single taxpayer can contribute the $5,500 per year to a Roth IRA ($6,500 if 50 or older) so long as their income is no more than $117,000 per year.
At higher income levels, the amount of money you can contribute to a Roth IRA starts to get phased out and goes to zero at an income of $132,000. For married couples filing jointly, your eligibility starts to be phased out at $184,000, and falls to zero at $194,000.
If you make too much money to contribute to a Roth IRA… well, congratulations! That’s a great problem to have. But it’s still a problem.
Luckily, there is a loophole. For those willing to do a little extra work, you can open a traditional IRA… and then convert it into a Roth IRA. That way, you can contribute past your “normal” eligibility.
Let’s look at some other options…
Say you’ve maxed out all 401(k) and IRA options. What next?
If you have a high-deductible health insurance plan, you can consider using a Health Savings Account (HSA) as an “extra” IRA.
HSA accounts are intended to be used for health expenses. But no one ever said you have to spend the money. You can let the money sit in an HSA investment account until age 65, at which point you can withdraw it penalty-free, just as you could with IRA funds.
Note: There are differences here. You can withdraw IRA funds penalty-free at age 59 ½. With HSAs, you have to wait that additional 5 ½ years to age 65 in order to use the funds penalty-free for non-health-related reasons. But, you can withdraw the funds penalty-free and tax-free at any time, so long as you use them for medical expenses.
Ok, let’s say you’ve done all of the above and you still have savings left to invest. If so, I applaud you. You’re clearly a disciplined saver. And luckily, there are some good, tax-efficient options for you.
In certain areas of the market, you can find tax-free bond funds yielding upwards of 6%. If you’re in a high tax bracket, that can be a tax-equivalent yield as high as 10%.
Rodney has all the details in a free presentation he’s giving next Thursday evening called “How To Generate 30% More Income Buying Discounted Investments.”
Both Rodney and I have been looking into this corner of the market for months and believe it will go a long way toward meeting your income needs, and in many cases, there are solid tax benefits as well.
Click here for more details and to sign up for the presentation. I think you’ll be pleased with the information Rodney brings to the table, and realize why we’re so excited about this opportunity. As far as I’m concerned, it’s one of the hottest opportunities you’ll find in the market today.
Editor, Dent 401k Advisor