Tax optimization and Roth IRA backdoor strategy

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How to optimize taxes? What's the Roth IRA backdoor?

The backdoor Roth IRA is a strategy to contribute to a Roth IRA when your income exceeds the limits for direct contributions . It involves making a non-deductible contribution to a traditional IRA and then converting that amount to a Roth IRA . This allows high-income earners to take advantage of the benefits of a Roth IRA .

The mega backdoor Roth is a variation of the backdoor Roth IRA for individuals who have access to a 401(k) plan that allows after-tax contributions and in-service withdrawals . It involves making after-tax contributions to a 401(k) up to the annual limit (e.g., $35,000), and then either rolling the after-tax funds directly into a Roth IRA or converting them to a Roth 401(k) within the plan . This allows for additional tax-advantaged savings beyond the regular contribution limits .

It is important to note that the availability of the mega backdoor Roth IRA depends on the rules of your employer's 401(k) plan, and not all plans allow for after-tax contributions and in-service withdrawals . It is recommended to check with your HR department or plan administrator to determine if this strategy is available to you .

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Brad Barrett: So that's why it's called this backdoor Roth. So what's happening is. you actually have a $53,000 limit. I think it's increased in 2017 to 54,000, but I know in, in 2016 it was definitely 53,000. So we'll go with that. And you can put in $18,000 of employee deferrals to your regular 401k. Right. And we always talk about, you want to max that out, right? Because that's, that's what lowers your tax liability. That's a tax deferred item. All right. So we highly recommend maxing that out. But the cool thing is you have that, that total $53,000 limit. So where we're getting the 35 is you just take the 53 back out the 18,000 that you've put in and that's $35,000. Okay. So that's the potential additional amount that you theoretically could contribute to your overall 401k. Now, what does include in that is your employers. Contributions or matches or whatever so that all gets added together up to this maximum fifty three thousand dollar limit but just for back of the envelope math will say there's no employer match you put in eighteen thousand you still have that thirty five thousand dollar limit. And now if you're fortunate enough to have a 401k at your company, and that does allow for after-tax contributions and in-service withdrawals, then you can put in up to that 35,000. You don't have to put in 35, obviously you, whatever you have extra lying around that you want to get into a Roth, you put that money in as an after-tax contribution.

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(someone): Let's just step back. I know we have a lot of new listeners in the Choose a FI audience. What is a backdoor Roth IRA? It's a transaction for those folks who make too much money to make a regular contribution to a Roth IRA. The idea is you first make a non-deductible contribution to a traditional IRA, right? That's $6,000, 7,000 if you're age 50 or older. That's no big deal. That doesn't move the needle too much in terms of tax or retirement planning. But the second step is where the elegance comes in. Many people can then do a second step where they do a Roth conversion of the amount in the traditional IRA. And if done properly, that second step does not create any additional income tax. So for higher earners, it gets money into Roth accounts when they otherwise would not have been able to do so. And the other thing that's also nifty about that transaction is folks in that situation typically cannot deduct a traditional IRA contribution anyway. So there's no tradeoff. There's no, oh, well, I'm doing Roth, but I don't get this tax deduction. That might be a reason not to do Roth. But in this case, for most high earners, if you don't qualify for a Roth IRA contribution, you probably don't qualify for a deductible traditional IRA contribution. And your best path is probably going to be just this backdoor Roth IRA. OK, that's great. In previous years, the practical deadline on this thing has been April 15th of the following year.

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(someone): You leave your job at some point, change employers, not even about fire. We're just talking about change employers and you roll money out of your employer 401k into your own vanguard. IRA, you have it all sitting there and your Vanguard IRA or whatever your Fidelity IRA, your Schwab IRA, it's yours. It's not owned or maintained by your employer and you get access to whatever funds you want. That happens all the time. People leave their employer, roll their money out of their employer 401k. So it's sitting there and now they've gotten a new job. They started their own business and they're at a point now where they're like. Dang, I just blew this game up. I'm not even eligible for a Roth IRA right now. You're telling me I can still fund it using this backdoor method, but the problem is. Their finances are a mess with this strategy mind currently, because they might have several traditional IRA still sitting out there that complicate this because of something called pro Rada. That that's kind of what we're battling up against. You're going to have this mix of money that was pre-tax and money that's now post-tax. And what you're suggesting is a stepwise process to clean that up ahead of leveraging a backdoor Roth technique.

(someone): That's exactly right, Jonathan. It's basically. What you would do is if you want to employ the backdoor Roth IRA for 2020, and you find yourself, Hey, I've got money in a traditional IRA from an old 401k, very common fact pattern.

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Brad Barrett: Now they have a decision to make going forward, which is every subsequent dollar that they put into a 401k or a traditional IRA is now only worth 10% in ultimate tax benefits in the current year. Right? So now they have a decision and I'm not so sure that I would continue putting in a tax deferred item. I might put into a rough ira or ralph for okay at that point now that's a decision of course they have to me but but at least it sets up for you the audience the conceptual framework of what we're working with here right so you have to look at those tax brackets you need to see where you fit into them And then like Fritz said, you need to make that decision on, on what makes sense for you based on your personal situation and your tax bracket.

(someone): And I think the framework that Brad just laid out is what that decision tree actually looks like. Specifically, you want to focus on the fact that your 401k is a vehicle to allow you to navigate some of these marginal tax brackets and make some of these other tools that you have available a little bit more appealing. And I think for both of us in our mind, once you can get down to that 10% marginal tax bracket, at that point, the Roth IRA looks very appealing, especially since now you don't have to jump through any hoops dealing with Roth conversion ladders. All that stuff goes out the window. You're already able to get that directly into the Roth. Yes, you're paying the 10% upfront, but that 10% tax rate seems like a very appealing fixed rate to know that you're paying and then to never have to pay tax on that again. I think that's just kind of a comprehensive way of looking at it.

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(someone): The big deadline on the backdoor Roth IRA is for those who already have money in a traditional IRA, SEP IRA or simple IRA. For those of you who don't know, if you have money in a traditional IRA, SEP IRA or simple IRA, it makes a backdoor Roth IRA very tax inefficient. I and many others have posted about this. You can look at materials online on that. But there is a planning strategy where you say, OK, I'm going to clear out my traditional IRA, SEP IRA, simple IRA by rolling that money from those accounts into my workplace 401k plan. or 403B plan or similar plan. If your workplace plan accepts that type of money, and they don't have to, but many do, if they accept that, then what you can do is by December 31st of the year you want to do the backdoor Roth IRA for, you can move that money from the IRA to the workplace plan. And now you're, I'll use a very technical term, now you're clean, right? So you can do a backdoor Roth IRA the right way. The other thing to think about, though, Jonathan, you can do a backdoor Roth IRA in 2020 for 2019. But again, you've got to be clean. But assuming you're clean for 2019 and 2020, in January of 2020, you could make a non-deductible Roth or traditional IRA contribution. And then I would recommend say in February of 2020, assuming your numbers all work, you could then do the Roth conversion piece of it.

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Brad Barrett: This is just a straight tax play because it's brilliant. Like He's created that taxable event, put it into his Roth, and now that money is tax free forever, but he's essentially paid $0 in tax on this. So it is a brilliant, brilliant play. If that works into your plan, right? As it did for, for Fritz here. So I absolutely love that. And I really wanted to, to make a point of that, that this is the Roth IRA conversion that he's doing. And it's, it really is a smart strategy.

(someone): And then I wanted to say that there is a distinct thing called the mega backdoor Roth. And I'm going to let Brad kind of introduce this concept as well. But before I do that, I wanted to talk about one point, which is in that episode, Fritz says that in order for you to be able to do this, your HR department has to allow in-service withdrawals. And the only reason I say that is I think some people took that as a mandatory requirement for HR departments. And I wanted to stress that unfortunately it is not mandatory. He was saying that in order for you to be able to do it, your HR department will need to offer this. Now, they don't have to, they're under no requirement to, and in fact, many businesses don't. But if you're lucky enough to work for an employer whose HR department does allow in-service withdrawals, then you should be able to do this. And so, it's worth going to your HR department to ask them whether or not they make that allowance.

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(someone): Not first, but you know, you have to do it in tax return. So that's why it's better if you can, in a short interval of time, withhold that paycheck, lots of amount on the paycheck, and then eventually move it to Roth IRA via the in-service distribution. Not every company allows that. So not everyone has this ability to do this magic trick. But if your company's 401k allows you to do that, it's one of the greatest techniques because you could put in 27k in your Roth IRA while you're only allowed to do 5.5k in the Roth IRA. The earnings, as I said, if the money grew, it has to be taken with you. Again, if you put the earnings in Roth, it gets taxed. If you put it in deductible IRA, then it won't be taxed because the earnings are still pre-taxed, right? However, the problem with that is if you're familiar with backdoor Roth, the traditional backdoor Roth, like contributing 5,500 to a traditional IRA and then converting it to Roth, If you leave your earnings in the deductible IRA, then while doing backdoor Roth, you might incur a taxable event. So I would advise, just buy the bullet, take it to Roth, all of it to Roth, and this is how it works. In my company, I contribute about 75% of my paycheck to after-tax. But again, it caps out at 54K. Thank you guys. If you have any questions, let me know. Bye-bye.

(someone): That was a very thorough walkthrough.

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Brad Barrett: comes fast and furious. So I know you understand it conceptually, but like if that can even happen to you, it can happen to anybody. So it's important to have the distinction between the Roth IRA conversion, which we've talked about it in the sphere of the Roth IRA conversion ladder, but mechanically it's just a Roth IRA conversion, which means you're taking money from a traditional pre-tax retirement account, like a, like a 401k, or really it's going to happen from, from your IRA and your, making a conversion okay so that is actually a taxable event you're taking money out of your pre-tax IRA and pulling it out and converting it to a Roth IRA now since a Roth IRA is after-tax money you actually have to pay tax on that conversion so let's say you pulled $30,000 out of your IRA converted to Roth that $30,000 goes onto your tax return as taxable income so even though you're putting 30 grand from your traditional into your Roth and that money's just moving one-to-one, you actually do owe tax liability on that. So to Danny's point, like it's important to keep track of that. Like if you all of a sudden at tax time, have a, if you're at a 25% tax bracket, you have $7,500 worth of tax on that, on that event. Now, hopefully most of us are not making that conversion if we're in that tax bracket. But again, You need to set aside that money for the tax liability on that conversion. So I think that is, is a crucial point and might help kind of make that distinction in your mind of what is mechanically happening with that Roth IRA conversion.

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(someone): that I think the audience will find very interesting, the so-called Mega Backdoor Roth IRA. This is something that's got a lot of press and a lot of folks are very excited about it. And I've seen it in the W-2 context at the large employer, where boy, that thing could be very powerful. And so what the heck is a Mega Backdoor Roth for the uninitiated? It's a two-step transaction using a workplace 401k plan, usually. It could be another plan, but usually it's a 401k plan. Could be a solo 401k, we'll come back to that. But what you do is you say, oh, you know, I maxed out that twenty two thousand five hundred. You know, I took that as a traditional and a Roth. I maxed that out. And what I could do in addition to that is these after tax contributions to the 401k. That's step one. So in addition to my regular twenty two five for twenty twenty three, I'm going to do these after tax contributions. That's step one. No tax deduction for that. It's not treated as a Roth. So by itself, not very helpful. But step two is where it becomes very, very helpful. Step two is one of two paths. It's a little choose your own adventure. I refer to them as 2A or 2B. 2A is I take that after-tax contribution and I roll it directly to a Roth IRA shortly after the contribution.

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Brad Barrett: So we do want to really play to the high income audience here for a second, because this is a nice little tool that that should be emphasized.

(someone): Yeah, now this is where the power of the backdoor Roth really shines. Now I threw a lot of tools in there and you probably won't have access to everything that I just said to reduce your AGI. So there's really no way that you're going to make over $300,000 and still qualify for this Roth IRA. through the front door. Now that is where we talk about the back door. And this is really cool. I have this article pulled up and this was written by the white coat investor. And I think he honestly is one of the premier resources on the backdoor Roth and the backdoor Roth tutorial. I will link to his various articles in the show notes. Uh, he was one of the first people I ever saw talk about this. And obviously physicians are really one of the most obvious career choices that are going to benefit from this as they are generally high income earners with access to lots of different vehicles. More income than they have vehicles. They're gonna really need to take advantage or consider taking advantage of something like this So he has an excellent article on it will link to it but in general the reason that this is possible is that in 2010 the IRS made a rule change and They got rid of income limits on converting funds initially made into a traditional IRA into a Roth IRA That is essentially what is gonna make the back to a Roth possible Now, there's three very, very important steps here.

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Brad Barrett: If you have a side hustle, that's making a lot of money, or you have a pension where you're going to have guaranteed income and your taxable income. So this is the play, right? Like the play theoretically that we always talk about, which is the beautiful five scenario is when you get to retirement, you have. $0 of income, and then you can do all this fun stuff, like pull out from your traditional IRAs and 401ks, which again are theoretically taxable events that go on your tax return. But because you do have some of that quote free money, right. With the standard deduction, personal exemptions, things like that, it would bring your tax liability down to zero on that. Right. So like, that's the beautiful play. Why we suggest so strongly that you control what you can control and put money into these tax deferred items and then boom maybe on the other side of retirement you can pull this out with zero tax rate so that's the beautiful thing but. For some situations that just doesn't work, right? Again, if you had a pension, if you had a side business, that's making money, like you don't want to throw away a business, right? Because you want to do some funny five hack. No, you have money coming in from a side hustle or a business or whatever it is. Obviously you want to keep that going, but it then precludes some of these amazing five hacks and that's fine, but you need to look at your circumstances. So Zach said, all right, my circumstances are I pay $0 in tax liability already. Let me funnel as much as I can into Roth options, 401ks and IRAs. That's brilliant.

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Brad Barrett: And now if you're fortunate enough to have a 401k at your company, and that does allow for after-tax contributions and in-service withdrawals, then you can put in up to that 35,000. You don't have to put in 35, obviously you, whatever you have extra lying around that you want to get into a Roth, you put that money in as an after-tax contribution. And then you have to actually mechanically make an in-service withdrawal. And that money then goes. As, as I understand it, it goes to a Roth IRA of your own. Okay. So that's hence the in-service withdrawal. You're actually withdrawing that money from that after tax account in your company 401k into a, an actual Roth IRA account. All right. And it is as simple as that. That's, that's the crazy part about this is why this exists, how this exists is beyond my comprehension, honestly. And. I can't imagine this will last forever, but again, if you have those two things, you can do this. And then it is a Roth IRA forever and it's tax free forever, even when you pull it out 50 years from now. All right. So that's the beauty of this. And of course, since this is an after tax contribution, that money is taxed currently. All right. It's. Just as if it was going to go into your regular savings account, you just decided to put it into this after tax contribution and the 401k, and then do this in-service withdrawal to get it, to turn it into a Roth IRA.

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(someone): But if you're lucky enough to work for an employer whose HR department does allow in-service withdrawals, then you should be able to do this. And so, it's worth going to your HR department to ask them whether or not they make that allowance.

Brad Barrett: Yeah. And that's built into the 401k plan. So it's not just like on the whim of like the VP of HR, it's what does your 401k plan allow? And yeah, the two keys to be able to do the mega backdoor. And I will explain that a little further in depth in a second, but the two keys are that they allow after-tax contributions and in-service withdrawals. Okay. So those are the two. Absolutely essential points so when you do talk to your HR department and ask them about the rules of your particular 401k. those two things have to exist in order for this mega backdoor to work. All right. So just reading that mad finds this article, Jonathan, that you quoted in the Fritz episode, uh, there are many people in the comments who were saying, Oh, this sounds great in theory, but my company doesn't allow for it. I don't, I don't know what percent of companies do 10, 20% of, you know, something like that. It didn't seem like an, a significantly large percentage, but that's just anecdotal, obviously. So the only way to know is to ask your HR department. It's as simple as that.

(someone): So I want to go and start off this segment on the Mega Backdoor Wrath by playing a voicemail that we got from Vishal.

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(someone): They're gonna really need to take advantage or consider taking advantage of something like this So he has an excellent article on it will link to it but in general the reason that this is possible is that in 2010 the IRS made a rule change and They got rid of income limits on converting funds initially made into a traditional IRA into a Roth IRA That is essentially what is gonna make the back to a Roth possible Now, there's three very, very important steps here. And the first step is you have to get rid of any money that is in a SEP IRA, a simple IRA, a traditional IRA or rollover money by December 31st of the year in which you actually do step three, which is the conversion from the non-deductible traditional IRA to the Roth IRA. And this is important because you have you need to avoid essentially what is called a pro rata calculation. And when you hear the word pro rata, think in proportion. Now, what does that mean? Well, what's happening here is you're taking advantage of this rule change and you're filling up your traditional IRA. You're not taking advantage of the pre-tax, you're doing a non-deductible contribution to it. And if you have money in your SEP IRA, simple IRA, any of those vehicles, and then you try to roll money over into your Roth, The IRS requires that you do this pro rata calculation, which basically means you need to take a ratio of your pre-tax to post-tax money as you pull it over and kind of imagine like your cream and your coffee, it's a challenge to separate those out. You don't want to go through that ordeal.

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(someone): Let's step back. And what are we talking about? Backdoor Roth IRA applies when your income is too high to make a regular Roth IRA contribution. But you still want to get some money into a Roth IRA. How do you do it? Generally speaking, the backdoor Roth IRA is the technique you need to use. But there are some pitfalls. And one of them is a year-end pitfall. And it's this. Let's say you worked at an employer through October. And then you leave. And you had a 401k there and you say, you know what, I want that 401k in a traditional IRA I control. So I'm going to roll that 401k into a traditional IRA. All right. And you do that in December. Well, what if you did a backdoor Roth IRA back in like January, February, and what happens is Having money in a traditional IRA at year-end is generally not a good thing if you're doing the backdoor Roth IRA. So for those in the audience that have already done a backdoor Roth IRA for 2020, the planning point is this. Just make sure by December 31st, you don't roll in any old 401ks, 403bs, 457s into a traditional IRA. You can do it in January 1st, and it's not going to be a problem for your 2020 backdoor Roth IRA that you already did. But if you do it before 2021, you could run into a problem for your 2020 backdoor Roth IRA.

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Brad Barrett: You need to set aside that money for the tax liability on that conversion. So I think that is, is a crucial point and might help kind of make that distinction in your mind of what is mechanically happening with that Roth IRA conversion. So when Fritz was talking about in their first two years in retirement, they were going to live off their investments, which is in bucket one in his three bucket strategy, right? They're going to live off of their just regular investments that they have sitting around. And they're going to convert as much as possible for the Roth IRA conversion. Now that's the play there. Okay. So what he's going to do is his taxable income is going to be close to zero, right? Because he's in retirement. He has no income coming in. He hasn't started his pension as we've discussed previously. So his income is zero. Now this is like the millionaire educators, free money concept, right? Like Fritz and his wife on their tax return, they will have. some amount of free money. And, you know, I don't know Fritz's tax situation, dependence, things like that. So, you know, I don't want to get into the exact amount, but let's say $25,000 of free money that he can convert from his traditional IRA to his Roth IRA each year and pay $0 of tax on it. All right. So that's the crucial point is he's living off these investments. This is just a straight tax play because it's brilliant. Like

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Brad Barrett: Yeah, yeah, that might be the understatement of the century, Sean. That is pretty cool. OK, so as always, I've got a couple of follow up questions. So we're talking both about regular 401ks with your employer and self-employed solo 401ks, things like that. Now this Megabackdoor Roth, it sounds like we just kind of were talking about the version where you were a W2 employee, where you were just an employee of a company. And so, okay, so right, that's the case. And right, you would have to basically go to your HR department and ask them, does our 401k allow for after-tax contributions, right? That's step one. And that's like, that has to be there. And then one of those other two of step two is in-service distributions or in-plan conversion to Roth 401k? That's exactly right, Brad. So as long as you have step one and then one of those step twos, then you've got an option for Megabackdoor Roth. Even if they've never heard the term Megabackdoor Roth, even if you're the first person ever, as long as those two things exist, you can do this. Cool. So then, right, as you're saying, this all additions limit for 2023, it's 66,000. You just subtract out what you put in for your employee contribution, and then the employer contribution, which would be the match. You add up those two amounts, and then you have that amount left in this all additions limit.

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(someone): Absolutely Jonathan the backdoor applies when you've made too much money in a year to make a regular contribution. To a Roth IRA I'm actually looking at the recently released IRS twenty twenty one phase outs for the income limitation. For Roth IRA in twenty twenty one it's going to be a hundred ninety eight thousand if you are married to two hundred and eight thousand. And for singles it's going to be a hundred twenty five thousand to a hundred forty thousand. So the big Starting points are, is my modified adjusted gross income $198,000 or less in 2021 if I'm married, $125,000 or less if I'm single? If that's true, then just go ahead and make a regular $6,000 Roth IRA contribution, right? If you're age 50 or more, it's actually $7,000 is your limit. But let's say you're above those two numbers, the $198,000 and the $125,000. Then you need to start thinking about this Backdoor Roth IRA. I and many others in the FI community have blogged on the Backdoor Roth IRA in terms of what you need to make sure you've got set up. We also have a New Year's Eve issue with the Backdoor Roth IRA. Generally speaking, Backdoor Roth IRAs make sense if you have no other traditional IRA, SEP IRA, or simple IRA. And the key deadline for what I call cleaning those things out is December 31st of any year. If you're at the end of 2020 and you're thinking, oh, maybe I'll do a backdoor Roth IRA for 2020, but you have an old traditional IRA from an old employer. It was a 401k.

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Brad Barrett: It's as simple as that.

(someone): So I want to go and start off this segment on the Mega Backdoor Wrath by playing a voicemail that we got from Vishal. He has access to the Mega Backdoor Wrath and he is going to quickly take a few minutes and walk us through how it would work practically.

(someone): Hello, Jonathan and Brad. This is Vishal calling from Silicon Valley, California. I'm calling because I was happy to hear that in the latest episode, you guys talked about the Megawatt and I wanted to send a quick voicemail because I do it myself, you know, regarding the steps involved in doing a Megawatt. So the first thing to understand is that your 401k to your employer can have three kinds of contributions. One is the pre-tax. The other is your employer's matching. The third is after-tax. And I'm talking about your traditional 401k. We are not talking about Roth 401k, which is a different beast. Now, among the three kinds of contributions, you might be already maximizing the $18,000 of pre-tax, which you're allowed to contribute. And your employer might be adding on another, I don't know, 8K, 9K to it. So you're sitting on like 26, 27k, let's go with 27k. But the 401k limit imposed by IRS is 54k per year. So there's room to contribute 27k more to this pie. And if you do that, and if you leave it in the 401k, it does not give you a lot of benefits. Number one, first, it's after tax money.

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(someone): I refer to them as 2A or 2B. 2A is I take that after-tax contribution and I roll it directly to a Roth IRA shortly after the contribution. Now, I just get that money into a Roth IRA. There's no additional tax unless there's a tiny bit of growth. They'll tax that, but that's going to be very tiny, if any. So that's 2A, right? After tax 401k contribution followed by direct rollout to Roth IRA. I've now just gotten a bunch of money into a Roth IRA tax free. That's pretty cool. I pay tax on the way in, right? The after tax contribution doesn't create a tax deduction, but I still got money into a Roth IRA and it could be 20 or $30,000. over a whole year. So that's pretty cool. Or instead of 2A, that direct rollout to the Roth IRA, they may allow an in-plan conversion. So I take that after-tax 401k contribution, say it's $1,000 for my March pay period. And later that same day or the next day, I just hit convert to Roth 401k. Again, no additional tax, right? And I'm getting all this money into the Roth 401k. And so the governor there is that all additions limit. Let's come back to that number, that 66,000. So what I do is I say, okay, my limit's 66,000. I subtract out the 22,500 in the regular employee contribution.

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(someone): Bye-bye.

(someone): That was a very thorough walkthrough. And then just to our audience, for those of you that are interested in getting a little bit more of a tutorial on this, Rishal shared with us a post that he wrote specifically because we brought this up. He got a lot of value from the episode, but he really wanted to highlight that. And I think Mad Scientist did a pretty decent job talking about it, but I think I think there's definitely room for another article on the mega backdoor Roth. And so we're going to put a link to this in the show notes. Uh, Vershall writes over it, everything about education.net. And this was a great walkthrough on how to tackle the mega backdoor Roth. I highly encourage you to check it out. It'll be in the show notes on today's episode. And before we move on, Brad, did you have any final thoughts on that? Anything else that we should clarify before we keep going?

Brad Barrett: Yeah, the, the mega backdoor. And this is kind of a bizarre thing. And we, and we laughed about it on, on the episode because, It seems like such a gimmicky loophole that like, it's hard to even imagine this exists. It's just allowing you to put in, in some cases up to $35,000 in money into a Roth IRA each year, even if you're excluded normally based on income limitations from like a regular Roth IRA. So that's why it's called this backdoor Roth. So what's happening is.

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(someone): So a couple of things here. One is I think of most people as maybe having some sort of charitable contributions. So, you know, it's that two to $4,000 a year range. Maybe you have monthly donations and it's kind of coming up to that two to $4,000 a year is going to charitable contributions. But you just said this is happening in a world where we have these massive standard deductions. So a married filing joint, $25,100, this massive standard deduction. You're getting that either way, whether you give a charitable contribution or not, you're getting that just married filing joint. So your two to $4,000 while well-intended is not in any way moving the needle on a standard deduction you would have already gotten. So you add in your, you know, uh, what, what are you paying in state tax and all of these things that you would use to itemize your mortgage, your mortgage interest extra, all these things you'd use to itemize, you add in your state tax, you add in your charitable contribution and, and you know, each year you end up landing with around $19,000 itemization, $22,000 of itemization, 23, 20, whatever. You know, from a tax purpose, you're getting no real incentive to contribute money to these charities, to these nonprofits. So how can we recognize that that's the lay of the land and get the tax benefit in a world where we're pretty excited about the standard deduction? It's good. We're not saying we don't want the standard deduction to go away. Keep it, keep raising it. That's great. Is there a way that we can still on top of that? And then what you're saying is it's timing.

Other ways to optimize taxes.

There are several ways to optimize taxes, including:

Take advantage of tax credits: Tax credits, such as the child tax credit, provide a dollar-for-dollar reduction in your tax liability . This can help lower the amount of taxes you owe.
Consider tax-efficient investment strategies: Investing in tax-efficient assets like index funds or ETFs can help minimize your taxes in taxable investment accounts. These investments tend to have lower capital gains distributions, reducing your taxable income .
Contribute to tax-advantaged retirement accounts: Adding funds to a Roth IRA or a traditional IRA can provide tax benefits, depending on your income and the type of account . Utilizing accounts like Health Savings Accounts (HSAs) can also provide triple tax savings .
Optimize asset location: Strategically allocating investments across different account types (taxable, tax-deferred, and tax-free) can help minimize your tax liability. For example, holding tax-efficient assets in taxable accounts and tax-inefficient assets in tax-advantaged accounts .
Maximize deductions: Take advantage of tax deductions, such as business expenses and charitable contributions, to lower your taxable income .
Consider geographic arbitrage: Moving to a location with favorable tax laws can help reduce your overall tax burden. Some countries have lower tax rates or special tax incentives for expatriates .

It's important to note that everyone's tax situation is unique, and it may be beneficial to consult with a tax professional or financial planner to find the best strategies for your specific situation.

348 | The Rules of the Game

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Brad Barrett: So that's a tax deduction. Whereas a tax credit is a dollar for dollar. That is truly the write-off that most people think, right? A tax credit is a dollar for dollar reduction. In the liability, the tax liability. So let's say you go through on your regular 10 40, you have all your income, you have all your deductions, you get down to your taxable income, and then you apply the tax brackets. And now naturally you're whatever, you know, TurboTax or whatever does this for you. You're not sitting there with a pen and paper, but you get your tax liability. And then let's say you've got the child tax credit. Well, that is a dollar for dollar reduction in that liability. Okay. So that is a 100%. There's a hundred percent value of a tax credit as opposed to a tax deduction is just worth whatever marginal bracket you're in. So hopefully that made sense out there.

(someone): Yeah. Yeah. So for instance, like in the tax credit scenario with the child tax credit, let's say you're in a 22% marginal tax bracket, you know, and you've earned $10,000 at that marginal tax bracket, which has created a $2,200 tax bill on that extra 10,000 that you earn a child tax credit of $2,000 would wipe out $2,000 of that. Right. As opposed to a deduction. would only take out a percentage of, you know, whatever amount was actually being affected. So tax credit, wildly preferable, but it doesn't. And this is a big point.

102R | The Triple Tax Savings of Health Savings Account

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Brad Barrett: This tax efficiency matters as well. So both of these are fantastic options. And I think you just need to read an article like this, look into it a little bit further, but I don't think you can go wrong with either, but it's not just as simple as looking at just that one number.

(someone): I don't want to poke the bear here, but I am curious and I'd like to dig into that just a little bit deeper. Just, I like to understand things and kind of get a sense. And I'd be curious just to pick your brain on this. So we are huge fans of tax efficiency and controlling your tax rate. And I know that we haven't really talked about this a whole lot in the show, but we do have a fair number of people in our community that are dividend investors, meaning they pick stocks that they know pay out a consistent dividend. And I would know one of the criticisms of that method has been that when you pick a utility stock or a company that's known to pay a two or 4% dividend a year over year, you're losing the flexibility of controlling your tax rate. And I'm curious as you look at specifically now an index fund and you think about an index fund, what does tax efficiency mean in the context of, of an index fund? Like BTSEX does pay out a dividend, right?

Brad Barrett: Yeah, Jonathan. So I'm on dividend investor.com and, and yeah, I see that there is a dividend history for VTS X. So yeah, it appears that they do pay out a dividend and that would be from the dividends being passed through from the underlying holdings. But I guess there are two components potentially to tax efficiency here. So there's the dividends, but there's also the capital gains.

122R | Dividend Deep Dive

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Brad Barrett: How do you see that that changed the game here in terms of this dividend investing strategy?

(someone): Yeah. So the, the dividend investing strategy, the tax inefficiency while you're still working is that you pay, you have to pay income taxes on the dividends every year, and that's a drag on your returns. And. you actually compound that drag by having to pay income taxes on, say, a 3% or 4% dividend yield every year instead of the 2% dividend yield in your S&P 500 index fund. So that could accumulate over time. And then on top of that, you are more likely to have lower income taxes in retirement. So again, once you reach retirement, you don't have this problem anymore of income taxes compounding because you are now at a stage where you are going to withdraw your dividends anyway. So I do use those as cash flow, potentially supplement that a little bit with selling some principle. And then out of that principle, part of it is cost basis and part of it is hopefully long term capital gains. So you're going to pay income taxes on this anyways, whether you pay the income tax on the capital gain or on the dividend. Right now, they are they are taxed at the same rate. So again, so in retirement, I could see that both from a tax point of view It's no longer prohibitive to have this dividend growth strategy. And then also from an asset allocation point of view, where you want to be a little bit more conservative, you have the low volatility, the lower volatility or lower beta stocks potentially in your in your dividend portfolio. But there's one problem. What if you have accumulated in your taxable account purely in an index portfolio, say S&P 500 or VTSAX, and now you want to shift

332 | Transform Your Tax Return Into a Springboard for Financial Planning

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(someone): They are corporate earnings that are returned to the shareholder. And today, a lot of dividends qualify for what's called qualified dividend income rates, which for many investors is 15%, but it could even be lower in terms of tax rate. So dividends are not the worst thing to have in a taxable brokerage account. Now, yeah, in a theoretical world, you could argue that any dividend investment should be in a retirement account where it could be tax deferred or tax free. I would argue in a qualified dividend income world, that's not that big a deal. Getting some dividends on your tax return is not, to my mind, the end of the world. That said, you might want to look at holdings that are, if you're, if you're planning on having high dividend holdings, then you might want to look at parking those in a retirement account versus your taxable brokerage account.

Brad Barrett: Yeah, that's huge. So, right. We're just talking, we're not talking about, Hey, change your life tomorrow, but this is just like you said, in a perfect world, kind of 1% better, all things equal. If you can put dividend paying stocks into retirement accounts, probably to your benefit.

(someone): Well, can I add on, uh, just a couple of thoughts that were, as we're kind of sitting with these ideas were coming to me, because when we talk about financial planning it, what we are looking at this through the lens of your taxable accounts. And although we have this very specific strategy that we really niche down on to talk about with charitable giving.

332 | Transform Your Tax Return Into a Springboard for Financial Planning

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(someone): If you're charitably inclined anyway, this is just a real winner in terms of, hey, I've got these capital gains. I don't want to trip them. Let me throw that onto a charity that I was going to give to anyway. Right. I mean, this is where the five community plays from a position of strength. So, you know, it's like, look, I have a checkbook. I can write a check, but I get a big tax benefit. If I just go into my brokerage account and do this transfer of appreciate stock.

Brad Barrett: Yeah, that's incredible. So, all right, Sean, we're talking about tax planning. We've obviously, we've talked a lot now about donations and capital gains distributions is where this started, but I guess You also touched in there about dividends and potentially where you hold dividend giving stocks or funds. Is that part of this tax planning as well?

(someone): It can be. So in terms of this particular idea, I look at dividends a little differently than I look at capital gain distributions, right? Capital gain distributions are just this thing that occur inside mutual funds and occur more inside actively managed mutual funds that don't add that much value, in my opinion, right, just my opinion, to the investor. Dividends, on the other hand, are not a bad thing, right? They are corporate earnings that are returned to the shareholder. And today, a lot of dividends qualify for what's called qualified dividend income rates, which for many investors is 15%, but it could even be lower in terms of tax rate.

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(someone): It's going to be taxed at your ordinary income tax rate. You have your Roth IRA health savings account. Money grows tax free and you can take it out tax free. And then you have your taxable accounts where your stock returns. So dividends have to be taxed every year. Capital gains only taxed when you take them out. And then also at a lower rate, right, dividends and long-term capital gains enjoy a reduced federal tax rate. And even some states have some incentives for capital gains and dividends, whereas bonds, bond interest would be taxed at your ordinary income tax rate. So there are definitely some ways of shuffling around your assets. So imagine you have a 60-40 target asset allocation. doesn't necessarily mean that you have 60-40 in all three buckets, right? Taxable, tax-deferred, and tax-free. So there are definitely some ways of shifting around. And I did some calculations on that, and it all depends on your tax situation, right? It depends on what's your marginal tax rate for ordinary income and what's your marginal tax rate for dividends and long term capital gains. So some people would argue that you keep bonds in your tax advantaged accounts because they generate income and it can. So you could keep your bonds in your retirement accounts because that's where they accumulate tax free and you keep stocks in your taxable account. Others would argue that, well, why do you want to keep the highest return asset in the worst possible account, which is your taxable account in some way. Why don't you just keep that in your Roth IRA where it can grow the fastest and with the with a zero tax rate?

332 | Transform Your Tax Return Into a Springboard for Financial Planning

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Brad Barrett: Like one of the things we're doing here at Tuesday, we're trying to just get people up to speed on this terminology. Cause it's so important, right? Like understanding the difference between a tax deduction and a tax credit is critical. And most people simply do not understand that.

(someone): Yeah, tax credit is just a dollar for dollar reduction in the tax you owe the IRS or your state. Tax deduction is great and it's valuable, but it's valued based on marginal tax rates. So that last, you know, we have a progressive tax system and we're actually in a period of relatively low marginal tax rates vis-a-vis US history, right? There have been times where the marginal tax rate for the very top was 90% or 70% or 50% as late as 90% was after World War II. I mean, there was issues with, Hey, we want to sort of suppress certain production and whatnot. You know, Kennedy cut taxes from 90 to 70% for the highest tier. Then Reagan came in 70 to 50%. Then in 86, they did 50 to 28%. Now it's gone back up. But for a lot of folks in the middle. We're looking at historically low rates, meaning tax deductions are worth something, but they're not worth quite as much as they were way back when. But that just goes to, hey, you know, today, a tax credit's even more powerful because a tax deduction, while valuable, isn't quite as valuable for many people.

(someone): See, I like to always look at the bright side. So when you have a 90% marginal tax break, I think how much the government is giving you when you contribute to these retirement accounts.

029R | Valuist

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Brad Barrett: This leaves me with the question of whether ETF shares held in Roth accounts offer measurable advantages over index funds due solely to their tax efficiency. I have a high level understanding of the differences in the way that index fund shares and ETF shares are constructed and redeemed, which can result in lower capital gains for the ETFs. But does minimizing an ETFs capital gains distribution actually produce any tax benefit or other cost savings for a shareholder who holds the ETFs shares in a Roth account? All right. So that was Mark's question. And I asked Ern if he should record a voicemail to this and he said, hi, Brad. No, that's a quick one. No need to record anything. The ETF advantage over the index fund doesn't apply in the Roth, just as you Brad suspected. You don't have to worry about capital gains distributions and mutual funds because in the Roth, everything is tax free. Same applies also to tax deferred accounts like an IRA, 401k, 457, et cetera, where the taxable event only occurs when withdrawing funds. In fact, Erin says the mutual fund has a few advantages over the ETF. One is no commissions when buying and selling. Two, no commissions when reinvesting dividends. Three, no bid ask spread when buying or selling. And four, easy rebalancing from one mutual fund to another with the same day transfers and guaranteed end of day prices. And five, you can buy fractional mutual fund shares, i.e. no idle cash sitting around. For those reasons, I prefer index funds in all my tax advantaged accounts.

332 | Transform Your Tax Return Into a Springboard for Financial Planning

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(someone): That means you as a shareholder are going to get $1 per share, so $100 dividend. If that's held in a taxable brokerage account, that's a taxable dividend to you. So in January, February, March of the following year, you're going to get a form called the 1099-DIV, which I sometimes refer to as a bill. Because what it is, is it's this form that says, oh, yeah, OK, shareholder, during the year, we paid you out $500 in dividends. And they report that to you. You then put that on your tax return, and you have to pay tax on that. But they're also reporting it to the IRS. So the IRS knows, hey, shareholder received $500. When they get that 1040 from you, they're going to expect to see that $500 dividend on there. So that's what happens. And that's part of the reason why we like retirement accounts. because in retirement accounts, you get these dividends, but you're not currently taxed on them. Taxable brokerage accounts are not a bad thing at all, but they do have this so-called leakage where, yes, dividends are paid by companies, and then you have to pay tax on that. And then when you go from one company stock to a mutual fund, so I own, say, the S&P 500 index, now I own 500 different companies, now I've got this situation on dividends and on these capital gain distributions. 500 companies in the S&P 500, some of them pay dividends. So that goes on my 1099 DIV, I pay tax on that. And then with inside that mutual fund, on occasion, they have to sell stock.

259 | Kristi & Big ERN

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(someone): And if you don't have any other short-term gains or even long-term gains for this year, you could write this off against your taxable income. And there again, we go into this whole tax arbitrage thing, which I hate. I hate to do that. I'm more of a finance guy, not a tax guy. And then actually the very low cost shares with the highest capital gains, you want to defer them as long as possible. I actually think that that's the one tax hack that I certainly want to do when I get to this point, when I have to sell shares in taxable accounts we're not yet in the position we actually have enough income in our retirement right now but if eventually we have to liquidate some of our stock index funds i definitely in my personal retirement i want to sell the ones with the highest cost basis and the lowest tax bill The reason is i want to get the there's a little bit of a tax arbitrage to begin with even if we eventually liquidate all of our shares because well i mean i want to defer taxes for as long as possible i want to pay taxes later rather than early so they said it's a time value of money consideration there. And then on top of that, eventually, my wife and I, when we are gone, we're going to leave our taxable accounts to our daughter. And if there's still money left, I want the lowest cost basis, the highest capital gains shares to go to our daughter. Because at least right now, the tax laws are such that if our daughter inherits that account, she resets her cost basis to the value at the time of our death. So her capital gains are basically forgiven at that time as a one-time present.

170R | A Capital Gains Case Study for 2020

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(someone): We just kind of arbitrarily said, well, three and a half percent safe withdrawal rate, let's work our way down and kind of go down that way. You could have worked it the other way and say, well, how can I squeeze every single penny out of the long-term capital gains tax brackets? And in fact, even if I don't need it, is there an incentive for me to do so? And I think the case that we could make, and it's a slightly different conversation, maybe we save it for another day, is that, yeah, you probably should and could, and there's a name for that.

Brad Barrett: Yeah. So that is capital gains tax harvesting. So now in this case, they still have another $6,000 plus of capital gains that would be taxed at 0%. Right. So in this case, it's $6,040. We're being very precise here. So

(someone): I love the precision with all the assumptions that we have. It's the best part.

Brad Barrett: I can't help it. I can't have it. What that means is they can realize another $6,040 of long-term capital gains and still pay $0 in federal tax on this. To me, the obvious answer is you should certainly do that, right? Even though they don't need this for their yearly expenses that year, they're not going to blow this money. They're not going to spend it. They're just making a very smart tax play. So the capital gains tax harvesting What they're going to do here, very simply, is they are going to sell this.

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Brad Barrett: And it's really important that we in the FI community understand this. This is a tax credit, which means once you've calculated your tax liability, then you pull $2,000 straight off of that. So it is a dollar for dollar reduction in that liability. That is contrasted with a tax deduction, which is just taking it off of your income. So the standard deduction, like we said before, if you had let's say $100,000 of income, the standard deduction reduces that income by $24,800 to get you then to down to your taxable income at which then you calculate your tax liability. So long and short of it, a tax credit is dramatically more valuable than a tax deduction.

(someone): And so basically what million are educators doing here, which I think is awesome is instead of even worrying about effective tax rate, we're shooting for how much can we make with an effective tax rate of zero, you know, forget marginal versus effective, just a tax rate of zero at the federal level with one child married filing jointly. $44,758 tax-free, effective tax rate of zero. With two children, I'm gonna work all the way up to five. With two kids, it's $61,425. With three kids, it's 78,000. I'm gonna leave off the change here. With four kids, it's 94,000. With five kids, it's $108,000 that are tax-free at the federal level. So that gives you a pretty substantial amount of room to work with.

Brad Barrett: Yeah, that is a really cool calculation, and it's interesting how he works backwards. We said, this is a $2,000 tax credit.

348 | The Rules of the Game

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Brad Barrett: And, and yeah, I think a lot of people say that like in a derisive way of, Oh, that company got away with something. They just wrote off that expense of that car or something as if it were free. And, you know, it's just, again, it's important to just understand how the world works when someone writes something off, which is just called a tax deduction. It just means that was a legitimate business expense. Whether you agree with the business expense or not is none of your business ultimately, but it's a legitimate business expense and that was taken. So you have your income and this is how a deduction works on your own individual return, right? Not just a business return, but it's the same concept. You have your gross income, right? Your sales, your whatever. and any expenses, like let's say you own a rental home, any legitimate expenses to, let's say, a repair, you get to deduct that. So you don't just report all of your gross rent and you don't get to deduct the management fees, the, hey, we needed to repair a ceiling fan or something like, no, of course, those are deductions. But again, to derisively say, oh, it's just a write-off, It's not free. It's just a percentage of it, right? Because again, it's the intersection of that marginal bracket, right? Jonathan, because you know, if it flows through to your individual return and you're in a 12% bracket, well, that deduction was worth 12% to you. So that's a tax deduction. Whereas a tax credit is a dollar for dollar.

351 | Year End Tax Planning 2021

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351 | Year End Tax Planning 2021

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(someone): So for that type of person, hopefully 10,000 is not life-changing, meaning, all right, if their roof needs a repair, hopefully they're financially independent enough that, okay, this is no cataclysm, this is no horrible event. I will figure out, I've got resources because I'm fine-minded to pay for the roof repair and I'm not missing that $10,000 too much in the donor advice fund.

(someone): So Sean, let's go ahead and move on. Let's talk about early retirement tax planning. And we're just kind of moving in my mind more to just a general checklist, right? These were big concepts that we were rolling through, just reminding they're so high impact, but now we're kind of, these are just things that we should be considering. Or does this apply to you? Someone that is on the early retirement bandwagon and they're on the glide path, they're getting ready, or they have just pulled the trigger and they aren't early retirement. Does that open up opportunities for tax planning?

(someone): Absolutely does. And this is the big thing where it's not about, hey, there's this one great one size fits all answer. This is about having an intentional process in place. If you are early retired, you have a great tax planning opportunity because you have artificially low income. So what I tell early retirees is, look, fourth quarter of the year, October through December, think about your year. How much taxable income did you generate? Capital gains, interest, dividends. And think about Roth conversions. And you'd have to do a bit of a subjective exercise. How much tax do I want to pay?

435 | Tipped Finance | Barbara Sloan

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(someone): I'm sure we could geek out all the time on this. Let's say you are a full-time W-2 worker. Your restaurant, your club has you on a W-2 and they are doing forced tip claiming where they're going to claim all of your tips for you. One of my favorite strategies when you do have a tax preparer is to have them write a letter of the amount of money that you pay out in tip-outs to deduct that from your income. So if you're tipping out every night to your barback and your bouncer and your busboy and any of the people that you're tipping out to, that's a deduction. And so you add up all of those tip-outs and give that to your tax preparer and say, we need to reduce my income by this amount.

Brad Barrett: Yes, that is so brilliant, because yeah, I'm sure a lot of people just get that, whatever the form is, whatever it may be, and just plop it on. But yet they didn't receive all that. So that those were their gross tips, but their net tips after Yeah, like you said that that is a standard practice that tipping out and If you have to immediately turn around and pay that as an expense as part of your business, in essence, that is a legitimate business expense. So clearly, clearly, clearly that has to be netted out on your tax return. So yeah, I'm super glad you mentioned that. I wanted to ask about, so we're talking about Things that people in the service industry might miss out on, but what are potential strategies? So now obviously we've talked about a little bit about retirement, a little bit about taxes. Now health insurance is a massive one.

274 | Tax Planning 2020 | Sean Mullaney

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(someone): Unfortunately it's per tax return. So it's only $300 per tax return. It's a little bit of a marriage penalty. Um, but you know, it's a little benefit and here's the thing. Most Americans do not itemize. So it is a nice little benefit to reduce your taxable income. Again, $300 is not going to get you to financial independence. But look, you're probably giving to charity, right? And if you give $500 a year and you've never been able to deduct it, and now in 2020, you get a little tax deduction, that's gravy. That's fantastic. So just make sure to keep those receipts and those sorts of things.

(someone): To be clear, what we're saying is, you know, a $300 deduction is that your current marginal tax bracket. So if you find yourself in a 24% marginal tax bracket, you get a $300 deduction. We're talking about, you know, uh, I'm going to get, I'm going to air my craziness here, but, uh, but it's probably, you know, sub $100 of benefit. Right. And not, not, not to write it off, but just so people kind of understand you're not, you're not paying $300 less than taxes. You're just reducing your AGI by that amount. So your current marginal tax rate needs to be applied to that to really demonstrate the full benefit. But, you know, it's, it's nice, nice gesture. Yeah.

(someone): It's a little something, Jonathan.

217| How to Save Thousands in US Federal Taxes Using Geo-arbitrage | David McKeegan

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(someone): If they structure themselves right, let's say they employ both spouses in the business, so all of a sudden they get two foreign earned income exclusions, so they can exclude just under $212,000 in income. They can take $24,000 as their personal exemption. And if they set up a 401k for their business, let's say their business is established in the United States, they can set up a 401k and they can each put $19,000 into their 401k. Let's say their company gives a 6% match. So they're each getting about a $12,000 company match. Now, all of a sudden, you're up to about $285,000, $286,000. That is pretty much all tax-free. The only thing you're going to have to pay is the Social Security tax, the self-employment tax, which is 15.3%. So your effective tax rate becomes just over 11%, and half of that's going to be paid by your business. So you're making almost $300,000, paying $32,000 in self-employment tax between the individual and the company.

(someone): Well, that's just awesome. Is there a list of these countries that, uh, don't, I mean, I'm sure there is a list. Do you have a list of the countries that you can provide for us that we can include in the show notes that have these favorable tax treatments for this type of strategy?

(someone): Uh, I don't actually have a list. I don't know if we've been asked for a list before.

(someone): How is that possible that no one's asked for a list?

435 | Tipped Finance | Barbara Sloan

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(someone): Is it the most tax advantage? No, it's not. We can be honest about that, but it's still a great option. It still means that you can retire and it still means that you could retire early.

Brad Barrett: Yeah, I love that. And yeah, like you're saying, there are potentially these quote unquote retirement, even if we wanted to go down that road, there are these accounts that you may have access to. Certainly, if you are a sole proprietor, you should have access to different options, such as the solo 401k, the SEP IRA, obviously, again, we're not giving advice here, but you should look into these things, you might have the option to Contribute to a traditional IRA, which is pre-tax or potentially a Roth IRA, whatever you decide, of course, but you're not shut out from these things. That's really important. And just one last thing, because this is my kind of geeky CPA thing, a actionable tip that we've passed along here a couple of times on Choosify that people just seem to love is when it comes to your tax return, and let's say you are underpaid and you made a good faith effort or you just didn't realize, and okay, You obviously owe your tax liability, no question about it. If there's interest that has accrued on it, you're going to have to pay that. But if the IRS ever sends you a letter or notice that has a penalty on it, my strong advice would be to reply with what's known as like a request for abatement. And that's just a big fancy word for please get rid of this stupid thing.

351 | Year End Tax Planning 2021

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(someone): And the cool thing is you actually have two options and you can max out. You don't have to max out, right? So you now have, if you have that over $100,000 schedule C, and it doesn't even have to be 100,000, but I'm just positing one example. That person can make 19,500 as an employee into a traditional or a Roth solo 401k, but it gets even better. So let's say that person, you know, computes their schedule C and it's a little over a hundred thousand. They take, there's a deduction on the tax return for half your self-employment tax. So you're probably familiar with, I'm sure you guys are, when you're self-employed, not only do you pay income tax, you pay self-employment tax, which is essentially the equivalent of FICA tax. for W-2 employees. So self-employment is great, but it's a great way to pay more tax. Okay. But you do get this deduction for half that payroll tax, that self-employment tax. So let's just say you add up schedule C and you subtract out that deduction for your payroll tax and the net number is $100,000 on the dot. Okay. You then take that $100,000, that net number, and now you just do an employer contribution to your solo 401k. up to 20% of that net number. So what have we done, right? For somebody who makes a little over $100,000 in self-employment income, they could do 19,500 as an employee, maybe 26,000 as an employee, plus up to another 20%. So that's $20,000. So that person could do this year 39,500 into their solo 401k through employee and employer contributions.

217| How to Save Thousands in US Federal Taxes Using Geo-arbitrage | David McKeegan

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(someone): I don't know if we've been asked for a list before.

(someone): How is that possible that no one's asked for a list?

(someone): I can tell you that Costa Rica, where I'm calling you from, is one of those countries. So Costa Rica does not tax you on income that you earn outside of Costa Rica.

(someone): Wow. Okay. So, so, and to play this out, to talk about your path to financial limits, to tie what we know about how tax laws work and how, if you have your own company and you and your spouse are married, filing joint, and you take advantage of the tax event and treatments, you can see how you and your spouse have been able to supercharge your path to financial independence by knowing the rules, as opposed to the beginning of your journey, where you were just paying an extra 20 K that was just owed by basis to the fact that the accountant that you were working with simply didn't exactly.

(someone): That's the thing that anybody living overseas really needs to pay attention to. It's the details in the tax rule that are going to make the difference in how much you're going to be charged in tax or not be charged in tax come the end of the year.

(someone): So it's cool about these types of strategies is you get through the one-on-one, which is already kind of cool and complex, but then when you get to the two Oh one, because you're inside the financial independence community, and because you've been looking at all the angles from all the different countries that you've had clients in all these different countries, and you've kind of seen all the different variations and you're intimately familiar with the tools that the financial independence community is talking about. I know that you took this to the two Oh one and three Oh one level.