Winston Churchill said, “We contend that for a nation to try and tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.”
Unfortunately, many of our government officials today don’t see it that way. Now don’t get the idea that I’m against taxes. I agree that some taxes are necessary and that they provide essential benefits to all. Taxes pay for good things like roads, bridges, schools, military protection and care for those who don’t have many resources. But we all know that a lot of our hard earned tax money gets wasted by our government. While we can’t directly control tax rates, we can use smart strategies to make sure we’re only paying what we have to.
If you have access to a 401(k) through your employer, this is a great first step in minimizing the taxes you pay. Money you put into your 401(k) plan comes out of your paycheck BEFORE taxes get calculated, so you won’t get taxed on your contributions. Another great part of 401(k)’s is most employers will match part of your contribution. This is free money available to you, so you’d be crazy not to take it! At least put in a percentage of your pay enough to get the most matching available. You won’t find many other investment options that can double your money overnight like that!
Once you’ve gotten the maximum match from your 401(k) contributions, the next best place to put your money is into Roth IRA accounts. This could be through a personal Roth IRA or your employer might offer a Roth 401(k) option. To be able to contribute to a personal Roth IRA there are income limits. If you are married filing a joint tax return, your MAGI needs to be under $189k to contribute the full Roth IRA amount. If your MAGI is between $189k and $199k your contribution will be reduced. If you’re over $199k you cannot contribute. If you make too much money to contribute to a personal Roth IRA, you can still convert regular IRA money into a Roth IRA. And if your employer offers a Roth 401(k) option, there are no income limits to be able to contribute to those.
OTHER TAX DEFERRED VEHICLES
The next place to go with your money would be to other tax deferred vehicles like annuities and cash value life insurance products. Now you need to tread carefully when entering these waters because not all of these products are created equally. Some are much more expensive than others, and some have much better returns than others. Most of the high fee, high cost annuities are variable annuities. There are some very low cost, no surrender charge variable annuities out there for people who don’t mind their money being invested in the stock market. Fixed annuities and fixed index annuities are totally different from variable annuities and can be a great solution for money that you want to protect from stock market losses. For someone to say that all annuities are bad is just plain ignorant. There are also cash value life insurance products out there with no surrender charges. These allow you to access your money right away if you need it for any reason. As a side benefit, these can also be a great way to protect yourself against long-term care costs. Some of these products have
TAX FRIENDLY STATES
Another strategy you can use to beat taxes is to relocate to a state that doesn’t have state income taxes, or doesn’t tax retirement income. There are only 7 states that have no state income tax. They are:
- South Dakota.
This is why you’ll commonly see a lot of high income earning athletes and business owners taking up residence in some of these places. These same 7 states, plus Pennsylvania don’t tax retirement income distributions. This would include money you take out of your IRA’s as well as pension checks. New Hampshire and Tennessee only collect state taxes on interest in dividend income. Of course you’ll want to consider all the other taxes the state imposes like sales tax, property tax, gas tax, etc. Do some research here to figure out which states would be most tax friendly to your personal situation. It might well be worth relocating to one of these places before you retire.
START UP A BUSINESS
Having your own business is a great tax shelter for many reasons. A business entity allows you to take tax write off’s for many things that your business needs, and that are things your already paying for. This could include things like your cell phone, your car lease or miles you drive, 50% of meals and entertainment (if for business reasons), some of your home utilities if you run your business from home, just to name a few. Many people will try to find a way to turn their hobby into a business. This is fine. However, your hobby will need to be profitable in 2 out of 5 years to be considered a business instead of a hobby. If you think this might be an option for you, talk to your tax professional to see if starting a business might help you reduce your tax bill.