The Best Way Americans Can Legally Reduce Taxes... Without Moving
The Best Way Americans Can Legally Reduce Taxes... Without Moving
Notes From the Field By Simon Black September 26, 2022
Legally reducing your tax bill is the best risk-free return on investment you can make. Investing in a completely legal tax strategy means keeping 10, 20, even 30% more of your own income. And in many cases the solutions aren’t especially exotic. For example, if you live in California, you can slash you taxes simply by moving next door to Nevada. Doing so eliminates California state income tax, which kicks in at 9.3% for income over $61,215.
Moving even further, from Nevada to Puerto Rico, means eliminating not only state income tax, but also US federal income tax.
Puerto Rico’s tax incentives allow you to pay absolutely zero US federal tax. Instead you’ll pay a low 4% tax rate on qualifying business income, and 0% capital gains tax on qualifying investment income.
Or you could move overseas and take advantage of the Foreign Earned Income Exclusion, which, in 2022, allows Americans living abroad to earn up to $224,000 (if you’re married) without being taxed by the federal government.
But for many people, moving is simply not possible— due to family, work, or other factors.
Luckily, there is another powerful tax reduction strategy that does not require a change of location: tax advantaged retirement accounts.
First, you can reduce your taxable income significantly by making pre-tax contributions to a Traditional 401(k) retirement account.
In 2022, you can reduce your taxable income up to $20,500 by contributing that amount to your 401(k). And if you’re 50 or older, you can contribute $6,500 more as a “catch up” contribution – for a total of $27,000 per year.
This means that your taxable income decreases by $27,000, potentially saving you thousands of dollars in taxes.
It’s worth noting that setting up a 401(k) is pretty inexpensive. So this strategy yields an extremely high return on investment, with the added benefit that you’re saving more for retirement.
People who are self-employed, or earn income from a side business, can increase that tax-free contribution even more by using a Solo 401(k).
This option applies to business owners without any employees, anyone who is self-employed, and even those who just earn a bit of income on the side— consulting, selling on eBay, driving for a rideshare service, or renting rooms on Airbnb for example.
In this case, your total tax-free contribution limit for 2022 rises to $61,000 (or $67,500 for those 50 or older).
And there are other benefits to using a self-directed Solo 401(k).
Most typical, employer-sponsored retirement accounts offer you a very limited range of investment options.
But with a self-directed Solo 401(k), you are able to invest in a much wider range of assets, including real estate, foreign investments, private equity, and more.
Eventually, you still have to pay taxes on the money you put into retirement accounts. Generally, this happens when you take money out of the 401(k) once you’re retired.
But since most people’s smaller retirement income puts them in a lower tax bracket, the overall tax burden is low.
I cannot overstate how beneficial it is to take steps to reduce your taxes. And here’s a simple example.
Let’s assume you have $50,000 of income each year to invest. If you did not set up a tax-advantaged retirement account, and simply invest that money through your personal brokerage account, you would owe, say, 20% tax on it first.
So realistically you’d be left with $40,000 per year to invest.
Assuming you average 12% per year, after 25 years, that original $40,000 would be worth about $680,000. That’s a pretty great return.
But now let’s imagine, instead, you put the money in your Solo 401(k). In that case, the money is tax-deferred, so there is no up-front tax. You can invest the ENTIRE $50,000.
Assuming the same return— 12% per year, after 25 years, the original $50,000 invested would be worth $850,000.
In short, you saved $10,000 in up-front taxes because you invested through a Solo 401(k). And that $10,000 tax deferral resulted in an extra $170,000 investment return.
So you can see how powerful this strategy can be.
Remember, this isn’t some exotic tax loophole that’s only available to the rich and powerful. This is a completely legitimate retirement structure that has been enshrined into law for more than 50 years.
The government wants you to save for retirement. Hell, the government needs you to save for retirement. They know Social Security is running out of money, so they’ve made it as lucrative and compelling as possible for you to set aside your own money for retirement.
There are so many options available, and these types of structures are definitely worth considering and learning more about.
To your freedom, Simon Black, Founder, SovereignMan.com