how to minimize my tax

[ER_Hopeful]

for 2013, I made around $110k (all from megacorp w2) plus $1k to $2k of dividends/capital gains from my vanguard funds. My taxable income is around $77k, married filing jointly, so that puts me in the 25%. I just bumped up my 401k contribution last month so by year end I will have maxed out the $17500 allowed (last year, I contributed $11k.)

anything else I can do? we don't have any health issues(knock on wood), so no need for HSA. Should I open a traditional IRA? (we both have Roth IRA)

I was reading this guy's blog, Early Retirement at 33: An Overview | Root of Good

quoting him
"Our tax strategies have been so successful that we ended up with a federal tax bill in 2012 of $600 in spite of gross earnings over $140,000. I consider an average tax rate under 0.5% to be pretty good! 2013 is even better. Our tax rate is 0.1% ($150 tax on $150,000 income)."

I'm very intrigued how this can be achieved.

thanks.

 

[aaronc879]

He goes into great detail how he got his taxes so low here:

$150,000 Income, $150 Income Tax | Root of Good

 

[RunningBum]

I just read through that post about how they got the taxes so low. There were some "perfect storm" things like having a 3000 cap loss carryover. That's not exactly good advice, to lose money on your investments so that you can pass less taxes.

They also deferred a tremendous amount. $63,500 between 401Ks, 457s, and tIRAs. That's deferring taxes, not avoiding them, and if they do this year after year they will find they have a much higher tax bill in retirement. Without doing close inspection, I probably would've done a Roth IRA rather than a tIRA and gone ahead and paid some taxes now and never have to pay again on that money as it compounds.

 

[LOL!]

No need for HSA? I don't get it. You said you want to save on taxes, so use a HDHP and get your HSA maximally funded.

More on minimizing taxes for a family making more than $200,000 annually:
Bogleheads • View topic - Taxes on a family with $200,000 gross income

 

[steelyman]

They also deferred a tremendous amount. $63,500 between 401Ks, 457s, and tIRAs. That's deferring taxes, not avoiding them, and if they do this year after year they will find they have a much higher tax bill in retirement. Without doing close inspection, I probably would've done a Roth IRA rather than a tIRA and gone ahead and paid some taxes now and never have to pay again on that money as it compounds.

Yes. We were able to contribute identical amounts to 403(b) and 457. No employer matches for either. There were no Roth 403 options till '08, but I jumped on it when there were. I am not aware of a Roth 457 (that really is "deferred compensation", not the usual retirement plan).

I suppose the interesting statistic is how much tax you paid over your life, not one year.

 

[ER_Hopeful]

No need for HSA? I don't get it. You said you want to save on taxes, so use a HDHP and get your HSA maximally funded.

More on minimizing taxes for a family making more than $200,000 annually:
Bogleheads • View topic - Taxes on a family with $200,000 gross income

I guess I haven't researched HSA enough, I thought it was like Flexible spending account. From a quick google, it looks like I can contribute up to $6500 and I can invest the $ like in a 401k, the $ stays with me if I switch jobs. But how do I take $ out to pay for medical expenses? do I first sell the fund, then use some kind of debit card to pay(assuming the account provides one)?

 

[Senator]

You can always buy a rental property or start a business. If you do that, even for a short time, you could have tremendous advantages.

That said, there is not much you can do with W2 income to offset it. Max out 401K, Max out Health Care Savings Account (HSA).

You can probably contribute to Roth, but that would not offset taxes. Keep track of deductions, like charitable donations, miles to these causes, etc.

By far the best tax shelter is a rental property.

 

[Animorph]

we don't have any health issues(knock on wood), so no need for HSA.

An HSA is pretty much a deductible Roth account. Healthy or not, I'd fully fund an HSA and not withdraw until it was time to withdraw from Roth accounts. Use it like a retirement account, not a place to park this year's health payments.

 

[Senator]

I'd fully fund an HSA and not withdraw until it was time to withdraw from Roth accounts..

Just curious, why would you do that? You have to pay medical bills no matter what. With federal and state taxes, why would you not want a ~30% return right away? You can always in invest the money you get back from the HSA in a index fund.

It would not grow tax free, but you get 30% right up front.

Also, I am not sure what the investment choices are for an HSA?

 

[Mulligan]

Just curious, why would you do that? You have to pay medical bills no matter what. With federal and state taxes, why would you not want a ~30% return right away? You can always in invest the money you get back from the HSA in a index fund.



It would not grow tax free, but you get 30% right up front.



Also, I am not sure what the investment choices are for an HSA?

Well if you have an HSA that allows you mutual funds or buy stocks in it, you can make money long term in it. Plus you do not have to worry about short term capital gains. I have been healthy since I started my HSA about 5 years ago, but I have kept all my dental and doctor visit receipts. I will just keep them all in an envelope and whenever I want to withdraw the money tax free 20 years or so down the road I will pull the money out. Let the tax free money grow for as long as possible and pay out of pocket as long as possible is my mantra. As long as I have the receipts I will let the money compound tax free over time.


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[RunningBum]

Just curious, why would you do that? You have to pay medical bills no matter what. With federal and state taxes, why would you not want a ~30% return right away? You can always in invest the money you get back from the HSA in a index fund.

It would not grow tax free, but you get 30% right up front.

Also, I am not sure what the investment choices are for an HSA?

First, you raise a good point that the investment choices for an HSA are often limited, and fees can be high. When you get a high enough balance, you have more options. But putting that aside, an HSA is like an additional IRA, with the advantage that you can pull the money out for medical expenses at any time, without paying taxes.

You got the 30% advantage as soon as you put the money in the HSA. When you incur medical expenses, the question becomes, would you rather pay them out of pocket, or withdraw from this tax advantage account? If you can delay from withdrawing from the HSA, you continue to let that fund grow tax free. I'd rather let my tax advantaged account grow.

Keep those medical receipts. At some point in life, probably when you are withdrawing from other retirement accounts, you can start draining the HSA. If you have "unused" medical expenses you incurred after you started the HSA, you can apply them and withdraw without paying taxes. So you got the tax advantage when you put the money in like a tIRA, but you didn't have to pay taxes on it as if it were a Roth IRA. This is a tremendous tax advantage, and that's why I'd refrain from withdrawing from the HSA as I incurred medical expenses, and instead let it grow to cover future medical expenses as well.

What if you remain healthy and don't have many medical expenses? You can still withdraw the funds in retirement (after 59.5, I think), but you will pay taxes on it, just like you do for a tIRA. So at worst case, it's like a tIRA.

This was also written up from memory, so check the HSA rules for yourself, but I think I'm at least very close, if I've worded things correctly.

 

[Mulligan]

RunningBum....Now I'm going on memory also, which may be wrong...be I think it's 65 when you can pull the HSA out penalty free as income. But also, which has been mentioned before in other posts....If you stay healthy like I hope too, you can still use the money tax free to pay for Medicare premiums or heaven forbid...nursing home "vacations".


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[FUEGO]

Yes, it's age 65 when you can withdraw from an HSA penalty free (non-qualified withdrawals being taxed at ordinary income tax rates sans penalty).

We maxed the HSA out while working. It's like a traditional 401k going in, and a Roth coming out (assuming it's for medical expenses). And as an added bonus there's no SS/Medicare taxes on the $6400 annual contribution (another 7.65% savings).

We have $54,000 in the HSA and spend next to nothing on healthcare right now (as 30-somethings with 3 youngish kids). But I can easily foresee a scenario where something bad happens health wise in our 40's or 50's that would require higher healthcare spending. Enter the HSA.

It's also partly like a Roth right now. The $5000-6000 we have spent on qualified medical expenses over the last 7-8 years can be withdrawn any time we want if we need some quick tax free cash. Just another tool in the tax planning toolbox.

As for the question of tax deferral and not wanting to pay the tax bill later - I'd rather punt on the taxes. I get to keep the money I would otherwise use to pay taxes and invest it. I can always decide later how to keep my tax bill as low as possible.

If I'm in one of those top 5% or 10% of firecalc runs where my $1.x million portfolio turns into $10 million? Writing the high five figure check to Uncle Sam as I'm spending hundreds of thousands per year won't be so bad (I think I can make it work). But if it turns the other way and I'm living on barely a million dollar portfolio (in real terms), I won't be paying much tax anyway.

My tax strategy of tax deferral is in effect a way to shift some risk onto the government in the form of an insurance policy. My investments do poorly, I owe them nothing. Investments do fabulously well, and I have to pay up big time.

 

[FUEGO]

I just read through that post about how they got the taxes so low. There were some "perfect storm" things like having a 3000 cap loss carryover. That's not exactly good advice, to lose money on your investments so that you can pass less taxes.

The $3000 cap loss carryover is such a yummy free lunch. Everybody has some positions that lose money. Sell them, move the money to a similar (but not "substantially similar") investment, and enjoy a $3000 tax deduction against ordinary income. Tax loss harvesting. For the size of portfolios that most here possess, finding $3k of losses isn't normally that hard (except perhaps when we're at all time market highs).

 

[pb4uski]

As a W-2 employee you don't have many options other than defer as much as possible (assuming you expect to be in a lower tax bracket in retirement, which is common).

So max out the 401k and contribute to a HSA. Think of the HSA as another tax-free retirement savings opportunity like a Roth IRA except even better because if you use the account for qualified medical expenses later on you never pay tax on that income or any investment earnings.

Also, in your case, a HSA for you and your wife, along with maximizing 401k contributions, may drop you down into the 15% tax bracket, where qualified dividends and LTCG are not subject to federal tax.

 

[LOL!]

It seems missing from the discussion is that not everyone is eligible to contribute to an HSA. One must be covered by a high deductible health plan (HDHP) in order to contribute. Penalties are severe for illegal/overcontribution.

If you are covered by an employer health plan that is not an HDHP, then no HSA for you.

Now suppose one has an HSA, but switches from an HDHP to another plan. One can keep the HSA, but can no longer contribute.

Have some fun reading the iRS pub on HSAs: http://www.irs.gov/pub/irs-prior/p969--2013.pdf

 

[pb4uski]

True, but since the OP indicated that they had no need for a HSA it suggested to me that it was available if the OP wanted to do one. And of course you need to have a qualifying health insurance plan.

I'll be dealing with that this year in that our HDHI plan for the first half of the year qualifies for HSA but our new catastrophic health plan does not.

 

[RunningBum]

...

As for the question of tax deferral and not wanting to pay the tax bill later - I'd rather punt on the taxes. I get to keep the money I would otherwise use to pay taxes and invest it. I can always decide later how to keep my tax bill as low as possible.

If I'm in one of those top 5% or 10% of firecalc runs where my $1.x million portfolio turns into $10 million? Writing the high five figure check to Uncle Sam as I'm spending hundreds of thousands per year won't be so bad (I think I can make it work). But if it turns the other way and I'm living on barely a million dollar portfolio (in real terms), I won't be paying much tax anyway.

My tax strategy of tax deferral is in effect a way to shift some risk onto the government in the form of an insurance policy. My investments do poorly, I owe them nothing. Investments do fabulously well, and I have to pay up big time.

Yeah, but you might be able to lower it only to a certain extent. You can't defer forever. There are a few people on here lamenting how they deferred the max only to find out in retirement that RMDs pushed them into a higher tax bracket in retirement. The blog poster would very much seem to be a candidate for that. And that person might also have to figure out how to bridge the gap from ER to being able to withdraw those funds penalty free. There are ways, usually, but not always.

As someone else said, your goal should be to minimize taxes over your life, not for a particular year. If you are pretty certain your taxes will always be minimal, then deferring the max might be a good idea. But if you have no idea, you'd better do some calculations because maybe paying a bit more than 0.1% or 4% now is better than paying 25% in the future.

 

[RunningBum]

The $3000 cap loss carryover is such a yummy free lunch. Everybody has some positions that lose money. Sell them, move the money to a similar (but not "substantially similar") investment, and enjoy a $3000 tax deduction against ordinary income. Tax loss harvesting. For the size of portfolios that most here possess, finding $3k of losses isn't normally that hard (except perhaps when we're at all time market highs).

Everybody? I have just one holding with a loss, just over $6K. I probably will sell it before the end of the year, but it won't even fully offset my gains that I've already taken this year. I have no carryover loss from last year. So, No, not everybody.

And as far as a "yummy free lunch" goes, I don't think of taking a loss on an investment as either yummy or a free lunch. At best it's a consolation prize. But hey, anytime you want to give me $10K as an investment I'll return $7K to you whenever you want so you can enjoy your $3000 tax deduction.

 

[tessaduncan]

So medical receipts can be submitted for HSA reimbursement years after the date of service? They don't need to be submitted during the calendar year they were incurred?

 

[RunningBum]

So medical receipts can be submitted for HSA reimbursement years after the date of service? They don't need to be submitted during the calendar year they were incurred?

I'm certainly relying on that. I've been saving those receipts for a few years. It is not a "use it or lose it" account like an FSA.

 

[Mulligan]

I'm certainly relying on that. I've been saving those receipts for a few years. It is not a "use it or lose it" account like an FSA.

Yes, I am doing this also. But, I am very high tech though. I keep all my receipts stored in an enveloped marked "medical receipts".


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[FUEGO]

Yeah, but you might be able to lower it only to a certain extent. You can't defer forever. There are a few people on here lamenting how they deferred the max only to find out in retirement that RMDs pushed them into a higher tax bracket in retirement. The blog poster would very much seem to be a candidate for that. And that person might also have to figure out how to bridge the gap from ER to being able to withdraw those funds penalty free. There are ways, usually, but not always.

As someone else said, your goal should be to minimize taxes over your life, not for a particular year. If you are pretty certain your taxes will always be minimal, then deferring the max might be a good idea. But if you have no idea, you'd better do some calculations because maybe paying a bit more than 0.1% or 4% now is better than paying 25% in the future.

That's actually my blog referenced in the OP. You're right. In another 36.5 years I may have to deal with RMDs. I'm hoping to pay a TON of taxes. If so, it means I'll have many times my current portfolio and paying $100k taxes on a $400k RMD won't be so bad. I might change my tax strategy later as I approach RMD age (in another couple decades) to smooth out the tax impact, but right now, I'm keeping my taxes at or around zero.

I have over 10 years in a taxable account that will give me plenty of time to fill up some Roths using a Roth IRA conversion ladder (tax free, of course). I may not pay any federal tax until age 70.

 

[ER_Hopeful]

so I checked my employer health insurance, it's a HDHP. I guess I'd be eligible. So how do I go about getting a HSA? do I open an account on my own, give them my payroll info and they will do the pre-tax deduction or do I start with my employer side first?

looks like Vanguard and Fidelity have FSA accounts.

Health Savings Accounts | Fidelity WPS

 

[LOL!]

My experience is that if an employer has an HDHP for employees that they have an associated HSA vendor that they make employee contributions to. So what did your employer tell you about the HSA that they have?

Otherwise, I can recommend HSA Bank. Once you have a balance above about $5000, there are no fees.