My pal and podcasting partner Kraig from Young Cheap Living and I have put together what we think is a fantastic Episode 5 in the Chasing Financial Freedom Podcast catalog.
This episode is going to focus on one of the inherent and unfortunately necessary evils in life: taxes. Specifically, we’ll be talking about why taxes suck and how you can minimize the drag taxes can have on your wealth over the long haul. Hint: dividends have tax efficiency built right in!
Kraig shares how much he’s paid in taxes for the year, and the crazy thing is that even though he’s paid a hell of a lot of money to the IRS already, he quit his job months ago and will end up with only about a half year of normal wage income. Kraig just realized that the amount he’s paying in taxes this year could fund a good portion of his lifestyle alone. Just another great reason to live on less!
I think a great title for this episode is: Taxes Suck – Take Advantage Of The System You’re In And Minimize Them.
We hope you sincerely enjoy this episode. We put a lot of content together here. We talk about how the capitalistic system we’re in should be celebrated rather than vilified. Instead of railing against the wealthy, figure out how to be wealthy. Instead of complaining about taxes, take a look at how the wealthy earn money and minimize their taxes and take a page out their book.
If you do enjoy the podcast please feel free to leave a review over at iTunes. It will help us grow the audience and hopefully inspire even more people in the future.
As always, you can subscribe to the podcast over at iTunes by clicking below:
You can also listen to the podcast via the included Quicktime embedded player below. This is for interested readers who don’t want to use iTunes.
The Chasing Financial Freedom Podcast: Episode 5 can be found below. Just click play!
Please let us know what you think. What do you think about taxes and our thoughts on how to minimize them over the long haul? Enjoy the show!
Thanks for reading.
Great podcast. Keep them coming.
Sounds Good DM,
Taxes are unavoidable, but you can minimize them by owning businesses directly or income producing assets. It really benefits us that dividend and capital gains are taxes at reduced rates. I also like that you got into talking about assets vs. liabilities. Very few people understand the difference, but there are very big differences. Also, I head you mention Rich Dad Poor Dad. You should read it. The author kinda makes my skin crawl, but the central concept of that first book hits home for a lot of people. In your case, I think it would mostly reinforce what you’re already doing successfully.
-Bryan
Oh boy do I agree that “Taxes Suck”. According to my spreadsheets, YTD, I’ve had more withheld from my pay-checks (FICA + Fed + State) than I have spent on living expense this year! That is beyond insane!
Hey Jason, while I agree that decreasing the number of years you are employed is a great way to minimize your taxes, I disagree that you shouldn’t also utilize tax-advantaged accounts during those working years.
In a recent article (http://madfientist.com/retire-even-earlier/), I created a hypothetical scenario that is not too different from the numbers you guys were discussing (a 30-year old, making $60,000 per year and spending $16,800 per year). By investing in normal taxable accounts, this hypothetical person could reach financial independence by the time he is 41. If instead, he maxes out his tax-advantaged accounts (i.e. 401(k), IRAs, HSA, etc.), he would be able to retire by age 39! That means, without changing anything about his income, savings rate, spending, or risk profile, he’d be able to knock over two years off of his already short working career.
Yes, it will be a bit more of a hassle accessing the money in his tax-advantage accounts prior to standard retirement age but I guarantee it won’t be as much of a hassle as working an additional two years!
I’d be interested in hearing your thoughts on my analysis.
Jason (and Kraig),
I’m really, really enjoying your podcasts. I just finished listening to the first four, and can’t wait to listen to episode 5 tonight when I’m doing my daily elliptical/workout after work. These podcasts are very educational and motivating. I always find a wealth of information from them, and find them incredibly entertaining/motivational. You guys are the best and doing amazing things with your podcasts and blogs. Keep up the amazing work and thanks for everything.
Sincerely,
Ian
I can’t get to your podcast–is the Quicktime embedded one working?
One way to reduce taxes is to reduce income. Or have some kids! Before retiring, you could live in a state with no income taxes–then after retiring, move to one with income taxes but lower other taxes.
Marriage can also affect taxes–it would raise mine (I have all the deductions my boyfriend has a higher income), but that’s not really a good reason to not get married.
I use retirement accounts at work and Roth IRAs. My extra investments are mostly in growth-dividend stocks. I got an HSA last year. I deducted sales tax the past few years (my state doesn’t collect income tax). I took the deductions when I did energy-saving work on the house. I itemize–even now that my house is paid off, property taxes + charitable contributions exceed the standard deduction.
I could do even better if I paid my property taxes twice every other year (right after January 1 for one year, then right before January 1 for the next year) and then took the standard deduction on the other years. That seems kind of slimy, plus I’m between jobs and haven’t known if I would have a decent income the following year from which to make deductions.
For property taxes, you can have a less valuable property. You want it just valuable enough for you to want the property, but not moreso. I’m trying to be careful with renovations. For example, I want to add covered parking. I think carports add way less property value than enclosed garages, so I may go that direction.
It’s good to keep up with what’s going on the tax world and read up on what’s new each year so you don’t miss anything. And sometimes it’s worth getting help if you move into unfamiliar territory (Turbo Tax has helped me figure out a couple of things that I couldn’t figure out by reading.)
Bryan,
Great point there. Taxes can definitely be reduced by moving from a traditional working class wage income to a business owner/investment income. That’s exactly what we’re talking about. The system rewards investors over workers. The best thing you can possibly do is move away from the latter and towards the former. The energy spent doing this instead of complaining about the system and/or your lot in life would be well used.
Take care!
FFDividend,
Thanks for the support! Glad you enjoyed it. 🙂
Best wishes.
Chicago81,
That is insane! I’ll have to take a look at my taxes here soon. I’m probably pretty close to your situation. Paying the government more than what it costs for your lifestyle is pretty crazy. I don’t think taxes are evil, or unnecessary. However, I do think one would be best to mindful of them and look for ways to minimize the payouts over the course of their lifetime.
Best regards!
Mad Fientist,
I read through the article.
I’ve admitted that I’m giving up a little cash by not investing in a Roth, but I think the flexibility and freedom I have by having full access to my funds at any time outweighs the small savings advantage. I’ve discussed this elsewhere, but I believe we were talking about a few thousand dollars at most.
Your post makes things sound a bit different. However, I find a few issues with it just as my real-life situation. First, my employer offers a 401(k) at work, but doesn’t offer a match. Furthermore, the fees are rather high. I wonder how that changes the calculations?
Also, people talk about the hassle of accessing money in traditional retirement accounts being relatively minor. I have yet to see anyone actually post a real-life case study on a SEPP over many years to show exactly how little the hassle is. I reckon it’s actually more difficult than some people like to claim it will be. I admit a Roth is rather attractive, however again the savings are relatively minor for me. I believe it amounts to an extra month or two of work. Much different than two years.
Best wishes!
Ian,
Thanks so much for the support! Glad you enjoyed the first four episodes. I hope you enjoy this one as well. 🙂
Let us know what you think when you listen to it tonight.
I’ll also be hitting the gym here in about 10 minutes. I like to get about 10-15 minutes in on the elliptical and then about 30 minutes of free weights. Health and wealth go hand in hand, right? 🙂
Cheers!
Debbie M,
You might want to try a new browser? I use Firefox and the episode loads fine on the embedded player. Perhaps it’s a cookie issue or something else?
Great points there. I like what you’re saying. There are many, many ways to cut taxes. Simply consuming less in general is huge, which will lead to a smaller house with smaller property taxes and less purchases which results in lower sales taxes. Income taxes are definitely the biggest part of the puzzle, but other taxes should be considered as well. Thanks for adding that!
Best wishes.
DM,
Make the most you can for the shortest time possible, excellent!
And Kraig, I would suggest NOT selling your Vanguard holdings and making them part of a larger picture that counts towards your financial freedom and build on it. Whenever you need to sell (for one reason or another) and grab a lot of gains it is expensive.
Best regards!
I got to work and checked my podcasts on my ipod and was pleasantly surprised with a new episode. Loved it as usual and find them very inspirational. There was one part where you mentioned ‘Rich Dad Poor Dad’, that was a great book I had forgotten about. I’m gonna have to re-download the audio version of that again.
You guys picked an excellent topic, taxation is a perennial force in the universe. I look forward to listening to the podcast tomorrow morning. Thanks for putting it together!
Katz,
Absolutely. It’s all about maximizing your income whilst minimizing your expenses at the greatest spread possible for the shortest period possible. The larger the gap between income and expenses, the shorter the time period of your life that you’ll have to work will be, and by extension you’ll naturally pay much less in taxes.
Best wishes!
Captain Dividend,
Hope all continues to be well on your journey!
Glad you enjoyed the podcast. I’ll have to check out that book as well. It just never seemed to interest me, but I’m always interested in a new perspective.
Take care.
Spoonman,
Hope you enjoy the episode. Let us know what you think. 🙂
While I think taxes suck, I also believe they’re necessary. However, that doesn’t mean I want to pay any more than I have to. I think the path to FI naturally decreases your exposure to taxes, which is a wonderful side effect.
Cheers!
LMT increased dividends by 15.6%! Good stuff! Too bad I didn’t buy more shares couple of months ago
gibor,
Nice increase! I missed the LMT train. I put my chips on GD, HRS and RTN. I wish I would have made room for LMT as well. 🙂
Best regards.
You guys sure don’t know very much about taxes
Anonymous,
Sorry this podcast was not to your liking, or you feel we lack knowledge on taxes. Hopefully the next episode will be more to your liking.
Cheers!
Not having an employer match and having higher fees would definitely decrease the benefits of contributing to retirement accounts but probably not as much as you’d think. Jim, from JLCollinsNH.com, asked me to run some numbers for a post he wrote on high 401(k) fees (http://jlcollinsnh.com/2013/06/28/stocks-part-viii-b-should-you-avoid-your-companys-401k/). The numbers revealed that although high fees are definitely a drag on investment gains, the fact that you are able to invest more of your money when contributing to retirement accounts most often outweighs the negative effects of the higher fees. For example, a person with $60K adjusted gross income per year would likely pay around $8500 in federal taxes. If that person decided to max out their 401(k) and IRA, their AGI would drop to $37K and they would only need to pay around $3600 in federal taxes. Being able to invest $4900 extra per year (i.e the tax savings) makes the additional fees relatively insignificant.
Excellent point about the SEPP! I too have never actually met someone or heard of someone who utilizes SEPP. I can’t imagine I will go that route either because I’d much rather utilize a Roth IRA conversion ladder instead (so that I’m not forced to take money out of my retirement accounts if I don’t want to).
Retirement accounts or not, as you mentioned in the podcast, minimizing your working years is a great way to reduce your taxes so that should definitely be the number one focus.
Thanks for the good chat and I look forward to your next episode!
I just finished the episode, very stimulating as always. One of my favorite parts was when you pointed out that people should focus more on how to improve their financial situation than complain about taxes or readily pursue welfare benefits. People love to adopt a victim mentality and blame outside forces for all of their misfortunes. If they focused on building financial strength instead of getting the latest iGadget, then our country would be in a much better position right now.
Thanks for checking. (Mmm, cookies. Ahem.) I tried a few more ways–the way that worked was going to Kraig’s page (thanks Kraig!).
I do think that taxing earned income higher than unearned income is crazy and not fair and biased toward the rich. But we luck out now that there are discount brokers (and low-cost index funds) so we get to participate even though we aren’t rich. Ha!
I also fear you’re in danger of blaming the poor for being poor. Like most people, you think of yourself as not rich, but your income is above average and you have no dependents and you’re young and healthy and lucky in a lot of other ways. It’s true that many, many people live paycheck to paycheck just out of laziness, peer pressure, ignorance, etc. But some people have had some really bad breaks and are in a position where it’s taking all of their energy just to keep their heads above water. I know you’re not talking about those people, but it sounds a little like you might be.
You talk about a middle-class lifestyle, but many, many middle-class jobs have been shipped overseas, so it’s not so easy to find such a job. Yes, a particular person can do more to try to get one of these jobs, but that doesn’t change the fact that there aren’t enough out there for everyone who wants them. So it’s not a conspiracy against us, but there is a general culture of profit at any cost that leads to these kinds of decisions being made on a large scale. Fortunately, you’re part of the solution there–vacating your decent-paying job for someone else!
Meanwhile, there are many areas in life where being different gives you advantages. Most people don’t make their money from investing, so there’s a loophole for us. Shopping and going to movies at unpopular times lets you avoid the crowds. Being willing to walk a little farther can get you cheaper (or free) parking. It’s good to have the mindset to keep looking for different ways to do things that even though most people don’t do things that way doesn’t mean there’s anything wrong with them.
For fun, I also looked up my income taxes for last year. Earned income: $45,300. Interest/dividends/capital gains: $1260. With a health savings account deduction of 2325, itemized deductions of 7755 (sales tax, real estate tax, charitable contributions), and a 3800 exemption, I’m left with a taxable income of 32,680 for a total federal income tax due of only 4340 (numbers rounded), less than half of y’all’s, way less than my living expenses (19K). Plus FICA and Medicare taxes of course. Definitely like the idea of just not needing earned income.
Spoonman,
Thanks for listening, and I appreciate the feedback!
I agree with you. People’s situations can be largely controlled via decisions. Good decisions generally lead to good results, while poor decisions generally lead to poor results. Of course, luck has some role to play. However, I believe fate is less cruel than people like to lead on.
Best wishes.
Debbie M,
I’m certainly not trying to stand on a perch and rail against the less fortunate. That was not my intention or meaning.
I’ve spent time variously around the extremely poor, middle class and upper class throughout my life. I only have anecdotal evidence, and statistics can be bent to prove various viewpoints. However, from my experience the poor tend to be in their situation because of poor decision making and lack of hope. The lack of hope feeds into poor decision making which then feeds into a further lack of hope. It seems to be a self-defeating circle.
However, my time spent around those of relatively expansive means has shown me that those people tend to be in their position due to work ethic and a desire to be in their position. They “want” to be wealthy.
Of course, luck has a role to play here. And I’ve been very open about my intentions to eventually gravitate towards philanthropy. I believe there are a lot of people out there that were given a bum rap. And I feel bad for these people. However, I also look at my own situation. I grew up in a house infested with drugs, alcohol and two irresponsible parents who didn’t properly care for their children. I could have easily gravitated towards the same. But I didn’t. I wanted nothing to do with that. I “wanted” more out of life.
I hope this helps explain my position.
Best wishes!
Yes, it does. Thanks!
I can understand NOT wanting to tie up your money to 59 1/2 when you want to retire by 40; but to hear you guys complain about paying high taxes (a large part of the podcast) when you’re not putting away $23000 in tax advantaged space ( $17500 in the 401K and $5500 in a traditional IRA) which would effectively adjust your income downward maybe into a lower tax bracket doesn’t make much sense to me.
Even tying your money up until 59 1/2 years old doesn’t seem to hold water. Let’s say you reach your goal of retiring by 40 and you don’t touch your tax advantaged money until 59 1/2 years old to avoid the 10% penalty (I figure you could rely on your taxable accounts for funds); I find it hard to believe that almost two decades of tax deferred growth isn’t going to be more beneficial than you keeping the money in your taxable accounts and paying taxes as you went along.
As far as your 401K being non-matching and offering crappy options (I’m with you here), you can always move these funds to cheaper/better options (i.e. Vanguard) when you separate from your job or you might have an in-service withdrawal option (although you would probably be retired per you plan to take advantage of this).
avburns,
I think you’re missing a huge point. If I was putting away the $23k in tax-advantaged accounts to minimize my taxable income (and tax bill at the end of the year) I wouldn’t be able to retire by 40. $23k represents a pretty large portion of the available capital I have to invest with. Putting most of that way into tax-advantaged accounts that I can’t easily touch until I’m 59 1/2 would make no sense for what I’m trying to do.
I’ve admitted before that for someone aiming for early FI/retirement like myself that investing in a Roth IRA might make sense, and I’m giving up a little bit of money by avoiding one. However, the extra month or two that I’ll have to work (in terms of lost capital) is well worth the freedom and flexibility I’ll have to access all of my money at any time.
Best regards!
Thanks for the response, Dividend Mantra.
I can understand not putting away the entire $23K and tying it up (I just mentioned that figure as a means of lowering your tax bracket because so much of the podcast seemed like a “government is taking too much money in taxes” rant and this seemed like an instant way of potentially lowering your taxes.).
That being said it seems like some part of that $23K could benefit you. I don’t know the exact ratio (probably something that an accountant would have to look at) but it seems like lowering your taxes and deferring taxes while compounding your money could work even in an extreme early retirement plan like yours.
I mean even putting some of your REIT’s in a traditional IRA seems like it might help in that again you’re paying potentially lower taxes and your reinvested dividends are growing tax deferred.
Again, thanks, for the response.
Additional note: I guess I’m looking at this like the flip side of what you said on the podcast.
You noted that by being retired at 40 you will have potential decades of not paying taxes that those still working are paying/have to pay.
I’m seeing you retired at 40 and not having to use your entire nest egg; whatever that amount of unused funds amount to; it seems like it would be better to not pay taxes on it then have to pay taxes on it every year.
Add to that: the benefit of being able to take this money off your taxes in the past and deferring payments to maybe age 70 1/2 years old (when you have to take a required minimum distribution); which would be almost three decades of tax deferred growth; it just seems like even if it was a few thousand dollars that it would be more beneficial than everything being in a taxable account.
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