Doctors are all worried that they are paying too much in taxes. Most of the time they are right. But they usually think it is because they're not FILING their taxes right, when in reality the reason their taxes are too high is that they're not LIVING their life in the way prescribed by the IRS. If you want to reduce your tax bill, you need to live your life differently. That often means getting married (or staying single if your partner is also a high earner), saving more for retirement, saving for college, saving for health care expenses, buying a home, starting a business, making less, buying health insurance, etc.
15 Dumbest Ways to Lower Your Taxes
In the quest to lower taxes, I often hear a lot of stupid ideas to lower your tax bill. Today I'm going to go over the 15 worst ones.
# 1 Make Less Money
This is probably the best place to start because it is the underlying idea behind many of the other ones. The best way to lower your taxes is to make less money. Just stop working. The problem with this method is that it leaves you poorer than working and earning and paying taxes on those earnings. Yes, your tax bill is lower, but the goal is to have the most after-tax, not pay the least in tax. This might seem obvious, but I see variations of this all the time.
# 2 Borrow Money
Guess what? You don't have to pay taxes on money you borrow. It doesn't matter if you borrow from your credit card, from a payday lender, from a bank, from your 401(k), against your whole life insurance policy, against your car, or against your house. You won't pay taxes. But what you will pay is interest. So this money is tax-free but not interest-free. You borrow after-tax money and you pay back the loan with after-tax money. There is no free lunch here.
That doesn't mean it is always a stupid technique. Imagine a 90-year-old with a very low basis on some shares of stock or a property. Her heirs may be a lot better off if she just borrows against it and pays a little interest for a few years until she dies and the heirs get the step-up in basis at death than if she sells the asset and pays the capital gains taxes that could be completely avoided if she owns the asset until she dies. But most of the time, borrowing money and paying interest on it instead of earning it and paying taxes on it is a losing idea.
# 3 Losing Money
You know another great way to lower your tax bill? Lose money. That's right. When you lose money, you don't have to pay taxes on it. It might even reduce taxes on your other income. You can subtract up to $3,000 per year in capital losses from your ordinary income. This is the underlying idea behind tax-loss harvesting, of course. But in tax-loss harvesting, the loss is typically temporary, but the tax break is permanent (okay, technically only permanent if you leave those shares to heirs or donate them to charity). You're not really selling the investment either, you're exchanging it for a very similar one.
But losing money is not a way to get richer, even if it does keep your tax bill very low. I had a huge deduction when I finally sold my accidental rental property. But I would much rather have not lost that money in the first place.
Another variation of this one is starting a business. Lots of people start a business and get all excited about all of the stuff they can deduct from it. Guess what? The reason you get those deductions is because the money was spent and is gone, leaving you poorer. If you start a blog, write off a few hundred dollars in expenses and make little income from it, you have a lower tax bill. But you don't have more money after-tax than if you had never started it. In fact, after a while (losses in 3 out of the last 5 years [in 2019]), the IRS won't even let you deduct your losses. They will just reclassify your “business” as a hobby.
# 4 Giving to Charity
I am a big fan of charitable giving. But it is a terrible tax reduction technique. Take my situation for example. My marginal tax rate is 42%. When I give $100 to charity, my tax bill is lowered by $42. But I'm $58 poorer. Yes, the tax incentives make it less financially painful to give (or alternatively, allow me to give more than I otherwise could) but I'm not coming out ahead. Giving to charity JUST to get a tax deduction is a dumb move. Obviously, if you want to give to charity, you should use that donation to lower your tax bill as much as you can.
Another place people get burned with this one is that they assume a donation is tax-deductible when it is not deductible to them. For example, if you are married and your total itemized deductions are $15,000 and you give $5,000 to charity, you're not going to get any deduction for it. It won't lower your tax bill one dollar. That's because $15,000 + $5,000 = $20,000, which is still less than the 2021 standard deduction of $25,100.
# 5 Getting a Big Mortgage
Florida has lots of gators…and tourist traps like this one.
Sometimes people buy a house “for the tax deductions”. This is even dumber than donating to charity for the deduction. Yes, property tax and mortgage interest (with certain limitations) are deductible as an itemized deduction, but again you're spending $100 in order to get $42. If you itemize. And the mortgage is less than $1M. And the total of property and income taxes is under $10K.
Don't me wrong, I would still claim those deductions, but don't pretend that you are coming out ahead by buying that house. The buy vs rent decision is far more complex than just whether or not you get a deduction.
To make matters worse, buying a house often leads to other spending like furniture, insurance, and even fancier vacations and schools as you try to keep up with the Joneses. Buying that big house might be a great way to lower your taxes, but it is certainly not a great way to get richer.
# 6 Cheating on Your Taxes
Here's another way to lower your taxes—cheat and lie. This is also ridiculously common. It reminds me of an email I had recently from a reader. His wife's parents sent her a W-2, but she had never done any work for them, never been paid by them, and certainly had not filled out any of the required paperwork. That's just cheating. Now I'm fairly aggressive on my taxes. I call the gray areas in my favor. I pay every dollar I owe, but I'm not going to leave a tip. But I'm also going to pay my fair share. What's my fair share? What the tax code dictates I pay. I still report income that the IRS has no way to know I received. Just like when I used to work for tips—I reported those too.
Why is this a bad way to lower your taxes? Well, if you get caught at a minimum you will pay taxes and penalties. If it is particularly egregious, you may even do jail time. But most importantly, it is morally and ethically wrong. “But it's just a little white lie,” you say. That reminds me of a Winston Churchill story:
Churchill: “Madam, would you sleep with me for five million pounds?”
Socialite: “My goodness, Mr. Churchill… Well, I suppose… we would have to discuss terms, of course… “
Churchill: “Would you sleep with me for five pounds?”
Socialite: “Mr. Churchill, what kind of woman do you think I am?!”
Churchill: “Madam, we've already established that. Now we are haggling about the price”
Don't cheat on your taxes, even a little.
# 7 Not Contributing to 401(k)s
Say what? Let me explain. I have long maintained that contributing to tax-deferred retirement accounts during your peak earnings years is the best tax deduction doctors can get. It's larger than almost anything else, especially if you have access to a 401(k)/Profit-Sharing Plan and a Defined Benefit/Cash Balance Plan. The best part about it is that not only do you get a massive deduction, but unlike charitable donations or mortgage interest, you still have the money. You get an upfront tax deduction, tax-protected growth for decades, and usually an arbitrage between the tax rate you saved upon contributing and the tax rate you pay upon withdrawal. But some people argue that you should not use a 401(k) for one of two reasons, both of which are technically true, but applied incorrectly.
The first is “You will pay more in taxes in retirement because the account will be larger.” This is true. If you put in $50K and save 40% on it ($20K tax deduction) and then 30 years later pull out $400K, and pay 20% on it ($80K tax bill) you will have paid more in absolute dollars in taxes. But you will have a lot more money than if you had never made the contribution. You are coming out ahead. In fact, this is still the case if you saved 40% ($20K) on it and paid 40% ($160K) on it.
The second is “You are paying ordinary income tax rates on those earnings instead of the lower long term capital gains rates.” This one is also technically true, but irrelevant. The best way to think about a tax-deferred retirement account is that it is actually two accounts, one a Roth/tax-free account owned entirely by you and the other a tax account owned entirely by the government that they would like you to invest for them for a few decades before you hand it over. If you withdraw at a lower rate than you contribute at, some of the money in that government account is actually transferred to your account. But even if you withdraw at the same rate you contributed at, the government account was simply never yours to start with. The earnings in your “tax-free” account come out tax-free. Whereas if you had not used the 401(k) and invested in taxable, the amount invested is the same size as the “tax-free” portion of the retirement account, but earnings now are taxable at ordinary, qualified dividend, and/or LTCG rates.
# 8 Contributing to Roth 401(k)s During Peak Earnings Years
This one gets a bit complex but is somewhat similar to the situation above. Doctors contribute to their Roth 401(k) with lots of excitement about having tax-free income later. The problem is they would have been better off using a tax-deferred account, so while they save taxes, they end up with less money overall. There are some exceptions to this rule (it can actually be really complex) including people with large pensions, people with lots of rental income, and super savers, but the general rule stands for most doctors—use tax-deferred accounts instead of Roth accounts whenever possible in your peak earnings years.
# 9 Pulling Money Out of IRAs/401(k)s Early
This is a technique recommended by lots of people trying to sell you something. Imagine you are an unethical (or ill-informed) insurance salesman and want to sell your wares to the American Middle Class. Where is their money? Well, it's all in their home equity and their 401(k)s. They don't have much of a taxable account or much income. So if you want to transfer their money to your pocket, you need to convince them to pull it out of either their home or their 401(k). One great way to do that is to scare them with the idea of having to pay “huge RMDs” or “large amounts of taxes” in retirement. Large RMDs are the ultimate first world problem. I know LOTS of retirees that would love to have huge RMDs. Yes, you will lower your taxes by doing this. But you will also lower the amount of money you have after-tax. It's a bad idea.
# 10 Whole Life Insurance
Speaking of insurance salesmen, whole life insurance is perhaps the classic method of lowering someone's taxes while leaving them poorer on an after-tax basis. The tax benefits of whole life insurance (and its cousins variable life and universal life) are dramatically oversold. Just like a term life insurance policy, the death benefits are tax-free. The reinvested dividends are tax-free (because they are technically a return of premium—i.e. you paid too much for the insurance you got). You can do a partial surrender (lowering your death benefit) and take your basis out first. And you can borrow against it (like your house or car) tax-free. That's it. In exchange for those “awesome tax benefits” you get a crummy return due to high commissions, high fees, and high costs of insurance. Because of the crummy return, you end up with less money overall. To make matters worse, if you decide you want out, the tax consequences go from bad to worse. If you have a loss when you surrender the policy (the usual story) it isn't deductible, unlike a loss in real estate or in mutual funds. You can exchange it to a low-cost variable annuity (VA) and let the value grow back to basis, but that's going to cost you the VA fees at a minimum. If you have a gain, you have to pay taxes on it at your ordinary income tax rates rather than the lower long term capital gains rates.
It gets even worse if the agent was able to convince you to buy whole life insurance INSTEAD of using a 401(k) or Roth IRA because you have now missed out on far superior tax benefits.
# 11 Putting Insurance Products in a Retirement Plan
If you thought just buying whole life insurance for the tax benefits was a dumb idea, you haven't seen anything yet. Some people, including a prominent physician making the rounds on the internet, advocate for putting insurance products like annuities or cash value life insurance INSIDE your retirement accounts. The primary tax benefit of annuities and cash value life insurance is the tax-protected growth—it isn't taxed as it grows. You already have that in a retirement account. Annuities and cash value life insurance may also receive asset protection from creditors in your state, but you probably have that already from the retirement account. So now you're paying all these extra commissions, fees, and insurance costs without even getting any additional benefit!
To make matters worse, putting life insurance into a defined benefit/cash balance plan actually eliminates one of the tax benefits of life insurance—the death benefit is now no longer completely tax-free. An amount equal to the cash value is now taxable to your heirs in the event of your death. The physician advocating for this technique thinks that this is a great way to buy insurance with pre-tax dollars. While it is true that it is purchased initially with pre-tax dollars in the plan, when the defined benefit plan is closed in a few years and you purchase the policy from the plan, you must do so with after-tax dollars. So in the end, assuming you didn't die in the first few years after you bought it, you're still buying it with after-tax dollars. If you did die in the first few years, your heirs would have been way better off if you had spent that money on a big huge term policy. If you decide not to buy the policy when you close the plan and just surrender it, you ended up with a crummy investment in your defined benefit plan and thus less money than you would have had if you had just bought traditional stock and bond mutual funds in there. Since most defined benefit plans are closed every 5-10 years, and most cash value life insurance policies don't break even for 5-10 years, you just bought an investment with an expected return of 0%. That's going to leave you poorer on an after-tax basis.
# 12 Tax-Loss Harvesting in a 0% Bracket
Tax-loss harvesting is a great way to save on taxes, right? Well, not always. Up to a taxable income of $40,400 ($80,800 married) [2021], a figure many children, students, residents, and retirees are under, the long-term capital gains rate is zero. The LAST thing you want to do is lower your basis in this situation. By lowering your basis, you may be increasing your future taxes if your income is higher in the future when you cash out of this investment. In fact, you might be better off TAX-GAIN HARVESTING up to those income limits. This raises your basis at no tax cost. Yes, you could still use $3K in losses against your ordinary income, but that isn't worth very much in those lower brackets and that benefit could easily be eaten up by the increased capital gains taxes in the future caused by lowering your basis today.
# 13 Forming an LLC
Here's one I hear all the time—”I want to form an LLC to lower my taxes.” I'm not sure what people are thinking. Maybe they think LLCs are eligible for lower tax rates or something. Or maybe they think there is something that can be deducted from an LLC but not a sole proprietorship. Both are wrong. An LLC is a pass-thru entity. It is taxed as a sole proprietorship, a partnership, or a corporation. But it isn't taxed as an LLC. And of course, any business expense that could be deducted from an LLC can already be deducted from a sole proprietorship, partnership, or corporation. An LLC does limit your liability and usually provides some asset protection and can make a business look more official. It is also a lower hassle way to have your business taxed as a corporation if you so desire. But it is not a way to lower your taxes.
# 14 Having a Child
This one does work for most Americans, but not for many readers of this blog. The child tax credit of up to $2,000 per child phases out pretty quickly starting at $200,000 ($400,000 married). Don't get me wrong, that's a lot better than it used to be and children lower taxes for docs under that limit a lot more than they did before tax reform. But don't expect any tax break at all if you are a very high earner. Plus, who are we trying to kid? (See what I did there?) This is a lot like charitable deductions and mortgage interest, yes, there might be a deduction, but you're going to spend a whole lot more on that kid than you will ever get back as a tax benefit.
# 15 Investing in Municipal Bonds in a Low Bracket
Sick of paying taxes on your money market fund, bond fund, or individual bonds? Just invest in a municipal money market, muni bond fund, or individual muni bonds. That interest is usually federal income tax-free and sometimes state tax-free. The problem is that if you are in a lower tax bracket, you would be better off investing in regular old taxable bonds and paying the taxes on the interest at ordinary income tax rates. In fact, you might even want to put those taxable bonds in a tax-protected account and put your stocks into a taxable account, which could potentially lower your overall tax bill even more. But either way, muni bonds are the wrong choice. They're even dumber if you buy them inside a retirement account where their growth is already tax-protected.
It is a good idea to make sure you aren't paying any more in taxes than you have to, but the 15 methods of tax reduction listed above are just plain dumb. Make sure you aren't using any of them.
What do you think? Are there any dumb tax reduction techniques I have missed? Comment below!
Thanks for great post. I’m nearing the end of fellowship so lots of free dinners with “financial advisors.” With your help, I’m able to recognize many red flags. Regarding #9, one these salesman told me to take my 401k with me when I leave because institutions often change the way it manages the funds of non-employees. Both my residency and fellowship 401ks are in the target date options for now. What do you think? Do you still have your 401k from residency or fellowship? Or have you rolled those into your current job?
My residency didn’t offer a 401(k). When I leave a 401(k), I roll the money into the best 401(k) available to me. In my case, that’s my military TSP. Be careful rolling it into an IRA because that causes the pro-rata rule to apply to your Backdoor Roth IRA.
As far as “non-employee being treated differently.” Well, they can’t contribute any more and they don’t get a match, but other than that, it’s pretty much the same in my experience.
Hey L.R., congrats on nearing the end of training! It’s a monumental achievement.
When I graduated residency, I did roll my 401k into my new employer’s plan. But I mainly did this for reasons of convenience and control.
It’s nice to consolidate accounts when you can. As your assets grow, you’ll likely accumulate more investment accounts, so why not make life simpler, eh?
But for me, my new employer’s 401k offered better Vanguard index fund options than my residency’s plan at lower fees, and it was easier to monitor and make changes via the internet. I think the only way to make changes in residency was by faxing in paper!
When you cross over to the “other side,” just compare the investment options of your old and new employer. This will help you make this decision.
I am currently helping a woman roll over her 401k from her employer plan. She left a couple years ago and hadn’t done anything with it. Wells Fargo who was the custodian of the 401k had it rolled over into an IRA with Total IRA and then Total IRA transferred it to a third organization charging fees all along the way. We are still trying to get the necessary paperwork together to get them to transfer it to her Vanguard IRA. Which takes a lot more messing around than the ten minute phone call that would have been necessary if she had rolled it over right away. Apparently there is a law that allows them to do that after an employee leaves and doesn’t take their 401k with them. She did not have a very high balance (less than $2k) which may have been a factor in Wells Fargo rolling it over, but I would still avoid leaving a 401k with your past employer unless you are confident they will not move the money.
I still have mine from residency with the custodian of that hospital system, and I graduated in 2013. So far the only thing that I’ve noticed is that they took back the non-vested portion of their match sometime in the last 6 months (I was 80% vested in the matching funds). Their plan is managed through Fidelity, and so is my current employer, so I can actually see both plans when I log into my Fidelity account. As long as there are no fees to do so, one of my financial goals this year is to roll the old residency plan over into my current plan. From a logistical standpoint it will just make things slightly easier to manage since the funds available and low cost options are virtually identical.
I think in some cases an employer might pay for some of the typical 401k administrative fees (anything above an beyond an ER in an index fund). If that’s the case, the employer may force the then-ex-employee to start paying those added funds themselves. But on the whole if the funds are good and not better at your new place of work, best to just keep it with the ex-employer
My residency 401k accepts rollovers into it and offers fantastic products through Fidelity like institutional total market index funds with expense ratios of 0.015. I could not have beaten that deal with any other option and was glad to have it when I changed employers and needed to rollover funds from both a 401k and cash balance plan to avoid having an IRA that would then have prevented backdoor Roth option. As long as you have a good option, there’s no need to roll over the plan right away. Keep your options open while you’re early in your career. (this includes keeping state medical licenses but that’s a topic for a different post). Awesome job graduating training with a 401k!
I suspect this is a great article because it is similar to what my accountant told me over the years.
Only part I do not get is the bonds in the 401K and stocks in the taxable accounts.
My issue with stocks in taxable accounts is that every time I trade them I pay taxes.
In a 401K that is not an issue. This allows me to follow a newsletter for stocks (trading) and get (theoretically) a higher return than buying some stocks and sitting on them for long periods. Makes my stocks more agile, so to speak. Also simplifies my taxes. Regarding Muni bonds – in California these can be a good investment. Some day my income will drop (hopefully not too soon) and the Munis will be sold (without a tax loss BTW) but in the meantime they are sweet – unless the tax laws change.
Stop trading stocks and following a newsletter and getting a lower return and then you can put stocks in taxable in a boring old index fund, save the newsletter fees, lower your tax bill, and get a higher return.
But yes, if you’re going to be trading investments all the time, it’s best to do that in a tax-protected account.
What i have been doing for the last 20 years (following a newsletter to invest in equities) has actually worked pretty well. It is entirely possible a different approach would have worked as well or better (or worse) but evaluating what is better is not a simple matter (for me anyway) as the taxes, risks, and returns are variable and affect investment choices. As a simple example, what is better – a 7 % return over 20 years with a relative risk of 1.1 or an 8 % return with a relative risk of 1.3? I honestly do not know! What about the tax laws effect? Yikes. You pick your advice and hope for the best IMHO. But so far so good.
Just bear in mind the data is pretty clear that very few people can pick stocks well enough to outperform an index fund in that asset class over the long run. So the obvious thing to do is compare your returns to the index fund. If they’re about the same or better, fine, no biggie. But what most people discover when they actually track things is that they are woefully underperforming, especially after-fee (gotta count in the cost of the newsletter at a minimum) and after-tax. Mark Hulbert has tracked newsletter returns for years and it’s pretty underwhelming. Maybe he tracks yours:
http://hulbertratings.com/30-year-scoreboard/
I picked my newsletters based on Hulbert’s eval of their previous 20 year (now 30 year) performance. I use two newsletters. One newsletter i use suggests different Fidelity mutual funds not individual stocks. I also use a different newsletter that suggest various Vanguard bond funds. I am mostly invested in Fidelity “select portfolios” for stocks. I use Fidelity because that was TPMG’s choice for our 401Ks. The reason i subscribe is mostly to know when to sell, buying things is EZ for me. It is entirely possible an index fund would have been better but who knows? when relative risk and taxes are factored in things get very messy, i am pretty nihilistic on knowing which is better. As i mentioned, I have done fine so far…
What do you mean who knows? That data is available. Might as well see what it is. If you found out you underperformed by 3% a year, would you change strategy? Of course you would. But how do you know if you don’t look?
// If you found out you underperformed by 3% a year, would you change strategy? Of course you would.// Not necessarily. What if there was far less risk in my under performing investments> But anyway…here you go…
Annual Returns (%)
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
+23.4 +31.3 +35.3 +20.4 +25.9 -0.9 +39.0 +5.2 +29.3 +21.7
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
+44.9 -14.9 -7.3 -14.7 +38.4 +7.4 +15.0 +13.6 +15.6 -39.3
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
+35.4 +11.6 +1.2 +19.2 +37.5 +14.6 -2.1 +12.5 +24.0 -7.2
Fine, change my phrase to underperformed on a risk adjusted basis. But the point is the same. Anytime you’re using active management you should honestly track how you’re doing to make sure it is working and stop if it isn’t.
Or have Hulbert do it?
It doesn’t sound to me like you’re following any one newsletter exactly are you? In which case Hulbert’s data isn’t very useful to you.
//It doesn’t sound to me like you’re following any one newsletter exactly are you? In which case Hulbert’s data isn’t very useful to you.// I have no idea how you arrived at that conclusion. You make it sound so complicated! I follow a Vanguard oriented newsletter for bond funds, and a Fidelity oriented newsletter for stock funds, and follow both exactly. All my bond mutual funds are with Vanguard and all my stock mutual funds are with Fidelity. It requires almost no thinking on my part, i just buy and sell whatever they suggest. I am sure a S/P 500 index fund would be even easier however, and maybe “better”.
Then you should be able to use Hulbert’s data. I just remembered you were mixing two of them. Doesn’t the newsletter/Hulbert tell you if the 500 index fund is better? That’s the usual benchmark.
S&P 500 Annual Total Return Historical Data
View and export this data going back to 1988. Start your Free Trial
Data for this Date Range
Dec. 31, 2019 11.48%
Dec. 31, 2018 -4.38%
Dec. 31, 2017 21.83%
Dec. 31, 2016 11.96%
Dec. 31, 2015 1.38%
Dec. 31, 2014 13.69%
Dec. 31, 2013 32.39%
Dec. 31, 2012 16.00%
Dec. 31, 2011 2.11%
Dec. 31, 2010 15.06%
Dec. 31, 2009 26.46%
Dec. 31, 2008 -37.00%
Dec. 31, 2007 5.49%
Dec. 31, 2006 15.79%
Dec. 31, 2005 4.91%
Dec. 31, 2004 10.88%
Dec. 31, 2003 28.68%
Dec. 31, 2002 -22.10%
Dec. 31, 2001 -11.89%
Dec. 31, 2000 -9.10%
Dec. 31, 1999 21.04%
Dec. 31, 1998 28.58%
Dec. 31, 1997 33.36%
Dec. 31, 1996 22.96%
Dec. 31, 1995 37.58%
Dec. 31, 1994 1.32%
Dec. 31, 1993 10.08%
Dec. 31, 1992 7.62%
Dec. 31, 1991 30.47%
Dec. 31, 1990 -3.10%
Dec. 31, 1989 31.69%
Dec. 31, 1988 16.61%
You don’t need to show it to me or prove anything to me. I suggest you track your own returns after fees, taxes, newsletter subscriptions etc and see how it goes.
L.R.
For now, keep them where they are. Sometimes your new employer plan will allow a “roll in.” Sometimes they do not. If they do not, then it is easy enough to ask the plan administrator to change the 401k to allow a “roll in.” Complicating matters is the fact that your new employer may have a less than optimal 401k plan. Hence, you may not want to roll it in. If you were to roll it over to a traditional IRA, it will cause you to pay more tax when you do the backdoor Roth IRA every year. This is called the pro-rata rule. Since half the year you have a fellow’s salary, and half the year you have an attending’s salary, it might make sense to roll it to a traditional IRA, and then convert it to a Roth. Part of it depends on how much money you have in it. If it is a large sum, you give up the opportunity cost of investing that money that now went to the government. Feel free to start a thread on the forum and I will chime in if I have time. List the specifics.
Physicians Capital Management, LLC
So many good points here!
It is somewhat funny how very smart people can be duped because of fear of taxes.
I hope no one has a kid just for the tax break. I am in a position to get the tax credit but I would absolutely rather if I could double my salary and not qualify. Also kids are VERY expensive. 2K a kid is nothing compared to what they cost. It does not even cover 2 months of daycare.
Another classic post!
Right now (and most likely for the next 4 years) I’m in the highest tax bracket. I have about half of my bond holdings in a Vanguard bond fund in my IRA and about half in a Vanguard tax-free bond fund in my taxable account. The tax-free bond fund in taxable makes sense right now because of my current tax bracket and the fact that I’ll be living off my taxable account when I retire in 4 years at age 50. My question is, what do I do with my tax-free bond fund after I retire and I’m no longer in the top bracket? The tax-equivalent yield won’t technically make sense to keep that fund anymore but I would still like to have some of my bond holdings in my taxable account until I’m taking withdrawals from my IRA at age 59. Do I just keep the tax-free fund?
Then exchange it for a taxable fund either in your taxable account or in a tax protected account (selling stocks there and buying them in taxable.)
Only reason to keep the tax free fund at that point is if it for some bizarre reason has huge capital gains.
I have made the mistake of investing (a percentage) of my contributions to a 401K Roth at my work enamored with the potential for never having to pay taxes on it again. Then I realized that I am likely to come out ahead later on with a traditional 401k because I’m at the highest tax margin now. Of course who knows where tax rates will go in future but I still think the odds are on my side that traditional is way to go.
For those who are worried about losing their mortgage interest deduction and use it as an excuse to pay off their mortgage fully, I have offered in the past a service where they send me how much interest in the past they would have paid to a bank and I would return 39.6% of it back to them if it made them feel better. So far have not had any takers.
A lot of the deductions get phased out at my income level so I am thrilled that the standard deductions have gone up as I never even went over the previous much lower standard deductions after I had paid off my home.
With the SALT deduction limitation, those who pay off their mortgages and don’t give much to charity are finding that there is no point in itemizing.
I like it! Interesting slant on an old topic.
I’m guilty of #1. Make less. I think it was a good change for me. Cutting taxes wasn’t my only motivation, but cutting back reduced my income and taxes. It also reduced my workload, liability, and stress level. There is a diminishing return on added dollars at the top marginal rates. As PoF has described those last work hours each week are paid at your lowest hourly rate since the taxes are highest.
#8. I do that too. I contribute to a Roth 401K. I don’t think the marginal tax rates are that high currently (on a historical basis). What will future rates be? I don’t really know. Playing the odds, I think they will be higher. I might be in one or more of those “exceptions” groups though. Plus I do contribute to a 457b also so I guess I am hedging my bets.
#14 cracks me up. My 14 yo said she heard we will “earn” $2,000 from a tax credit because of her. She “knows” we will make money because of her. She wanted to know what her portion is – since that would be fair. Or I could increase her allowance now. OMG. I explained the phase in income limits. She said if your income is that high then you could really afford to spend more so, either way, a higher allowance should work. Can you believe it? I think my kids will be running negotiation workshops soon. And I will be the first to sign up. I have a lot to learn.
Yes, Wealthy Doc, part of my plan is making less, so I’m not certain its the number one stupid way to reduce taxes. It can be a step towards retirement.
Example:
At present, I make high wages for Psychiatry by having a full-time primary job that pays a market wage for my 25 years of knowledge and experience as Chief Medical Officer (really a fancy name for Medical Director with ~ 20% Admin time). I have a side hustle that pays half again my regular wage but requires me to work >20 weekends and several holidays a year (to leverage the hourly wage to the highest possible by taking work no one else wants). I put the max in the company 401 (with 5% match) and the max in the 457, max out the HSA, and then max out a SEP IRA on the side business to reduce my current taxes to the minimum. They take so much off the top of my check I need the side hustle to pay my bills…
Anyway, I will eventually sell the “big” house (4000 sq ft), move to a smaller house (still 2800 sq ft) with much lower maintenance electric, and lower property taxes. I will drop to 1-2 days a week (my idea of retired allows a few days a month of work) and my wages will drop by $300,000. Of that $300,000 fully $100,000 goes to TAXES. With the one or two days a week, I’m making a lot less money, but my federal tax bill drops to $20,000 a year.
I don’t need “things” anymore, and I will have funded a four year education for four children. All I need is time and less stress. At some point, the many taxes (federal, state, SS, Medicare, self-employment, etc.) make marginal dollars barely worth earning. Now if you are able to build up significant passive income, its less of an issue, but for me, all my marginal dollars require me to trade time (life) for that money and the government takes a lot of it.
I get the point, making less money isn’t the best way to reduce taxes, but in some ways I can’t wait to dump the “big house life” and start the “cabin in the mountains” life.
I disagree with #6. Cheating on your taxes is easily the best way to save money on your taxes. As long as you don’t get caught. You know, it’s just like speeding. Perfectly legal as long as you don’t get caught.
(All of this is said in jest, in case someone can’t read the sarcasm). 😉
Do you think WCI speeds? Or occasionally samples a grape at the supermarket?
Uh oh, they’re on to me.
Ha. My point was that if you do, the Winston Churchill ethics argument that you use isn’t very convincing.
(Yes, you could argue that ethical and legal aren’t the same thing, but millions of taxpayers have ethical issues with the tax code that are bona fide to them. I’m not even sure I can verbalize any ethical issues with speed limits, although I speed all the time.)
The comment about LLCs isn’t quite right, though the situations where LLCs can in fact result in tax savings are highly complex and need the advice of a tax professional. Suffice to say, LLCs taxed as S-corporations can have certain benefits that a sole proprietorship does not.
(None of this is legal advice.)
So….what exactly is wrong with the comment?
Any thoughts on this for those of us who have a larger mortgage above $750k?
https://www.svb.com/blogs/mary-toomey/maximizing-deductible-interest-expense
Seems a little squirrelly to call it investment interest expense but I suppose money is fungible.
Personally, I wouldn’t be very comfortable owing $2.5M for anything.
It’s interesting because the interest on the mortgage above $750k becomes “deductible” (again), so it doesn’t need to be a huge mortgage like in that example, just anything over $750k.
So for those in HCOL areas that want to keep their mortgage (to take advantage of low rates) and have enough investments in the stock market can use this strategy: pay off their mortgage, then do a cash-out refinance for the same amount as their previous mortgage, and invest that. Then the interest expense is deductible.
Another article on it: https://cressetcapital.com/post/borrow-more-invest-more-deduct-more-cash-out-refinances-present-unique-tax-and-investment-opportunities-for-homeowners/