One For The Money

This episode is part two of my series summarizing how income taxes work. I know taxes may not be the most exciting topic, but I share this with you because you don’t pay less accidentally. Instead, paying less in taxes results from being proactive in your approach and executing strategies over many years. You’ll want to listen so you can take advantage of these tax-saving strategies.

• A review of incomes [01:38]
• A progressive tax code [02:58]
• Paying taxes to your advantage [05:16]
• Roth Conversions for early retirement [06:50]
• The Augusta Rule for business owners [09:53]

In episode eight, I went over the stages income goes through before taxes are applied. All income received in total is called gross income, and, provided certain adjustments are made, taxes aren’t owed on that entire amount. These adjustments would include IRA, retirement plan, and HSA contributions. After these adjustments are made, the income is called adjusted gross income, and taxes aren’t applied to that amount either. There’s one more phase called the deduction stage, for which there is either the standard deduction or itemized deduction. 

Once income has gone through these adjustments and deductions, the remaining income will be taxed. Here in America, those who earn more income pay a higher tax percentage. This system is what’s called a progressive tax code. Under current tax law, portions of a person’s income are taxed at different rates. Each level is called a tax bracket or marginal tax rate, which aren’t necessarily the most self-explanatory terms. Averaging an individual’s tax rates will result in what’s known as the effective tax rate.

Choosing the best time to pay taxes is especially important with retirement accounts because those amounts are only taxed once. People in a lower income tax bracket will want to pay taxes now if they expect to be in a higher tax bracket in retirement. This situation could occur for people who are early in their careers or semi-retired with a reduced income. For those in a higher income bracket now than retirement, it would be more advantageous to make contributions that will be taxed later.

A great example of this is setting up accounts for clients’ children. I have helped them start Roth IRAs because the children are very early in their careers and would pay less in taxes now. Clients who are retiring in their mid-fifties who have a pension plan that starts at age 65 will have a higher income in retirement. Over the years before their pension began, we do Roth conversions where we convert a portion of their traditional IRA from a pre-tax basis to a Roth. I’ll explain more on Roth conversions in a future episode.

This strategy is commonly referred to as the Augusta Rule, as it was created to protect the residents of Augusta, Georgia. The good news is that all of us can benefit from this provision of the tax code. Section 280a of the IRS tax code allows all homeowners to rent out their primary residence for up to 14 days per year without reporting the rental income on tax returns. The residence could be rented to individuals looking to stay on vacation, or you could rent to a business owner who intends to use it for business purposes such as a retreat or meeting. 

Even business owners can rent their homes to their businesses. Employing the Augusta Rule can be an effective strategy for moving income away from your business and shifting it to personal income where there would be no tax consequences. The corporation can deduct the rent on the business tax return if the total rental does not exceed 14 days and the rent is reasonable. The business owner wouldn’t have to report this income on personal taxes. 

• 2021 and 2022 Tax Brackets and Other Tax Changes
• Masters Tournament

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In this eighth episode of the One for the Money podcast, we cover a critical component of building wealth and early retirement: not paying more for taxes than necessary. While everyone has to pay taxes, no one says you have to leave a tip. Listen to learn more about reducing what you pay in taxes to have more of your money to spend in early retirement.

• Gaining a general knowledge of taxes [00:39]
• Income taxes and how they’re calculated [02:56]
• Adjusted gross income [04:50]
• Modified adjusted gross income [06:19]
• Types of deductions [07:49]
• Major expenses in itemized deductions [09:44]
• The Augusta Rule [15:31]

Pursuing strategies to reduce what you pay in taxes will help ensure you have more of your money to spend in early retirement. Implementing these tax mitigation strategies requires a general understanding of taxes. While taxes may not be the most exciting topic, it’s essential, and I’ll try to make it as interesting as possible. 

Taxes can be incredibly confusing, and the terminology certainly doesn’t help. Terms like gross income and adjusted gross income are confusing enough, and now they’ve added modified adjusted gross income. There are also above-the-line deductions versus below-the-line deductions. The list goes on and on. This confusing terminology makes many people want to ignore taxes altogether. However, if taxes are ignored, more will likely be paid in taxes than necessary. Reducing taxes is about implementing specific strategies based on general knowledge and understanding of taxes over many years. 

There are two ways to determine deductions. One is called the standard deduction, which everyone can take. The other is the itemized deduction which includes additional adjustments for qualifying expenses. If these deductions total higher than the standard, the itemized deduction would be used.

The standard deduction for 2021 is different for single, married, and head of household. The deduction for single is $12,550, married filing jointly is $25,100, and head of household or people caring for a qualifying dependent is $18,800. This option, of course, is if you choose not to itemize your deductions. However, if you’ve had certain expenses in total that were higher than the standard deduction, then you would want to itemize. Four major expenses included in the itemized deduction are medical expenses, state and local taxes paid, interest paid on a mortgage, and charitable contributions. These are considered below-the-line deductions because they may not lower your taxable income if the standard deduction is higher.

This episode’s tips, tricks, and strategies portion is a tip that may sound too good to be true, but true it is. This tax mitigation strategy is commonly referred to as the Augusta rule, named after the famous golf course on which the Masters Tournament is played every year. Section 288 of the IRS tax code allows homeowners to rent out their primary residence for up to 14 days per year without needing to report the rental income on their individual tax return. That’s a lot of tax-free income potential that can be earned every year. This rule was created to protect the residents of Augusta, Georgia who had rented out their homes to attendees of the golf championship.

The rent charged must be reasonable and in line with what the rental market supports. Charging $1000 per night when comparable houses rent for $200 per night is not considered reasonable. Homeowners can rent their homes to individuals looking for vacation opportunities or rent to business owners who intend to use the property for business purposes. Whatever you choose, this could be a great way to generate income tax-free.

• Credits & Deductions for Individuals | Internal Revenue Service
• Masters Tournament

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What are the best retirement saving strategies for the self-employed? We’ll be talking about that answer in this episode of the One for the Money podcast. I go over the relatively unknown Personal Pension Plan strategy that has allowed some of my clients to put away over $300,000 in a single tax year. In the end, I’ll talk about some strategies for employees who don’t have access to a 401k type plan. Listen to learn more about the options available to you.

• Retirement considerations in self-employment [01:19]
• Deciding when to be taxed on retirement savings [02:45]
• Advantages of Roth vs. traditional IRAs [04:51]
• SEP IRA and solo 401k [05:35]
• The Personal Pension Plan [10:35]
• W2 employees without access to 401k [14:50]

Many Americans dream of being their own boss. Self-employed professionals such as sole proprietors and independent contractors are living out that dream. While they have the opportunity to reap the rewards of being their own boss, they also assume all of the risks. One of those risks is saving for retirement, which is entirely up to the individual since there isn’t a company to provide a matching contribution.

A self-employed individual has several options available, and choosing the right one will depend on income. The simplest option is to have an individual retirement account. These come in two varieties, Traditional and Roth. These types of accounts are only taxed once with ordinary income taxes. With a traditional IRA, taxes are applied in retirement, and with a Roth, taxes are applied now. 

Deciding when to be taxed is based on income level. If your income is on the lower side, I typically recommend you pay the income tax now and contribute to a Roth. If you’re in a higher income bracket and expect to have a lower income in retirement, you’ll want to wait to pay your income taxes then. There are a lot of factors to consider, so it’s recommended that you check with a certified financial planner.

A solo 401k has the advantage of allowing higher contributions with smaller incomes. Also, more can be contributed to a solo 401k via profit-sharing contributions from your business. Another advantage is having the option of traditional or Roth. Something to keep in mind is that while a solo 401k can have a loan taken out on it, I’d only recommend borrowing from it to avoid bankruptcy. 

All these features come with an additional administration cost. A solo 401k is subject to IRS ERISA rules, so a third-party administrator is required to help manage the plan paperwork and annual filing requirements. The contributions for a solo 401k have to be established within the same tax year they’re made. The employee contributions need to be made within the year or the first few weeks of the following year.

Those who are W2 employees without access to 401k plans may be wondering what their options are. Unfortunately, retirement plans are similar to healthcare; employers usually provide the best options. Your next best options are either a traditional IRA or a Roth IRA. After maxing out contributions for the year, a further option would be to save in a non-retirement account. However, with a non-retirement account, you’re taxed multiple times. Taxes are paid on the money invested, which was already subject to income tax. Then, if you’re receiving dividends and interest, taxes will be paid on them as well. Finally, when an investment is sold for a gain, taxes will be paid then as well. 

Non-retirement accounts have the advantage of paying long-term capital gains if the investment is held for more than a year. Another advantage is that the funds are accessible any time instead of waiting until age 59 and a half. Also, if there are losses in a non-retirement account, they can be offset against gains to mitigate taxes that would have to be paid. Overall, there are a lot of factors to consider, which is why I recommend speaking with a certified financial planner who will evaluate your entire financial picture when making a recommendation.

• Employee Retirement Income Security Act (ERISA) | US Department of Labor

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In this episode of the One for the Money podcast, I share what you can do to ensure you have a fulfilling retirement. The process has less to do with money than you might think. In the tips, tricks, and strategies portion, I’ll share the first of many tax strategies as we approach the individual tax filing deadline of Monday, April 18th, 2022. You’ll learn the multitude of reasons you should seriously consider Roth IRAs for your children. Listen in to learn this and more!

• Looking back to look forward [01:15]
• Replacing your work identity [04:48]
• Preventing loneliness [07:55]
• Preparing your kids for retirement [11:38]

A successful early retirement is way more than pursuing the correct financial strategies. It’s having a plan that enables you to do the things that matter most. In the inaugural episode of this podcast, I went over where happiness is ultimately derived. In this episode, I dive deeper into two of those areas: meaning and purpose. 

You may be baffled by the idea that retirement can feel a bit depressing for some people. For early retirees, it can feel more so. We forget that we get a lot of meaning and purpose from our careers. Finding that same level of meaning and purpose in retirement doesn’t happen accidentally. It requires significant planning.

When you look up the word retirement, you’ll see images of people relaxing on a tropical beach or traveling the world. These images convey feelings of liberation, relaxation, happiness, and joy. But reality can be very different from what you see online. However, your retirement can be even more meaningful with the right type of planning.

As I shared in the first episode, much of what makes us happy has nothing to do with money. True meaning doesn’t have to be something grand like solving world hunger. It can be as simple as spending more meaningful time with your family or volunteering for your community. Ideally, we can find an activity that provides meaning, purpose, and true fulfillment. 

Another way retirees plan for success is by staying relevant and connected. As an early retiree, many of your friends and family will still work. Losing connections at the workplace can lead to increased feelings of loneliness. Because of that, it’s crucial to become involved with organizations before you retire so you can look forward to spending time with people you already know.

In the episodes leading up to the 2022 personal tax filing deadline, April 18th, I’m going to be going over strategies to not only prepare you for early retirement but to do so in ways that may reduce the taxes you pay in the process. While our focus is on early retirement planning, you may also want to consider helping your children get started on their early retirement planning as well.

We always want to pay taxes when it’s to our advantage. Obviously, that would mean paying when income tax rates are the lowest. As a child, that rate could be as low as zero. Therefore, contributing to a Roth IRA as a child can mean never having to pay taxes on the amount contributed during this period. As an investor, the single most powerful thing you can do is increase your time horizon. By having your kids set up a Roth IRA, you give them the gift of decades more time for their investments to benefit from compound interest. 

• Maslow's Hierarchy of Needs | Simply Psychology
• Robert Laura
• The Psychology of Money: Timeless lessons on wealth, greed, and happiness

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One of the more challenging aspects of early retirement is the topic of this episode of the One for the Money podcast: Obtaining and paying for health care. Medicare isn’t an option until age sixty-five. Stick around for the tips, tricks, and strategies portion where I’ll be discussing when it makes sense to get life insurance through your employer and when it’s better to get your own!

• Planning for healthcare after retirement [01:08]
• Options for healthcare [03:37]
• Healthcare sharing plans [06:09]
• Life insurance is critical for financial planning [08:57]

After housing and transportation, healthcare is the third-largest expense people will have when they retire at age 65, and that’s with Medicare! Early retirees don’t have this option. Even if you elect to accept Social Security at age 62, you still won’t be eligible for Medicare until age 65. Early retirees also need to consider the health status of those relying on them for their healthcare. 

The most generous healthcare plan is the employer’s retirement healthcare benefits. A fortunate few have employers who provide paid-for health care in early retirement. This perk is so tremendous that it’s no longer offered to government and private employees. However, some people have been grandfathered into this position. If you’ve worked for several decades, you should review your retirement healthcare options with your HR department.

Even if you retire early and leave your employer, you can still receive your healthcare through them for a certain amount of time. This option was made possible via the Consolidated Omnibus Budget Reconciliation Act of 1985, known as COBRA. However, you typically will have to pay the total cost of your healthcare coverage plus an additional 2% because your employer subsidizes a significant portion of these costs while you’re working for them. This practice is a perk to attract employees and provides the employer with a tax deduction.

Term life insurance is all you need. If someone tells you that you need permanent life insurance, they are likely an agent trying to earn a much higher commission by selling it. You should only consider permanent insurance if you are on track for retirement, have a fully-funded emergency fund, and have no consumer debt. Even then, it’s hugely debatable. Life insurance cannot legally be sold as an investment because it isn’t. Another thing you need to know about life insurance is that the price you pay is based on the probability of your passing away.

Life insurance from your employer isn’t based on your health but solely on your age. Consequently, if you are in poor health, it may be in your best interest to get life insurance through your employer. If you are in good health, that will likely be more cost-effective. A benefit of getting your own policy is that you still have it if you leave your job. In the end, it’s imperative that you have life insurance if there are people that depend on you, such as children, a spouse, or loved ones.

• elaws - Health Benefits Advisor
• Love Insurance

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The previous episode of the One for the Money podcast was all about strategies to generate income in retirement. Many might consider Social Security as part of an early retirement income strategy since you can begin receiving payments as early as age 62. In this episode, I’ll share with you why you most likely don’t want to try that approach. Listen to learn about how your Social Security benefit is calculated and how you can get a peek into what your projected benefit will be.

• How is Social Security calculated? [01:15]
• Reasons to wait to take Social Security [04:02]
• When should you start SS benefits? [09:44]
• Is investing early SS benefits a reliable strategy? [10:59]
• Social Security strategies for married couples [13:05]
• What could happen to Social Security? [14:43]

President Franklin Delano Roosevelt signed Social Security into law in 1935. Americans who paid into Social Security will receive a check each month from Uncle Sam to help pay for retirement expenses. Many might consider Social Security an integral part of an early retirement income strategy. However, there are thousands of reasons why you want to consider waiting to take this benefit. 

It’s essential to make the best decision regarding your Social Security benefit because you only have one chance to make the right decision. Once you’ve made that decision, you’re stuck with it for life.

Social Security benefits are based on lifetime earnings. Your past income used by the Social Security Administration to determine benefits is adjusted to account for inflation. This process ensures you have a much higher benefit. Any dollar you earned in the 1990s is equivalent to the dollar you earned in the 2020s. While your benefit is based on the highest 35 years of earnings, you’re eligible for Social Security after working for just ten years. But of course, your benefit will be much smaller. The longer you wait, the higher your benefit will be.

The question is when you should take social security. The answer to that can be challenging to predict because it depends on one factor: life expectancy. If your family medical history and genetics are good, and you’re in relatively good health, it’s likely in your best interest to delay taking the benefit for as long as possible. When you take Social Security, Delaying maximizes your benefits and can significantly mitigate the effects of market fluctuations and general price increases. In other words, by delaying your benefit for later, you’re going to have a more guaranteed income.

As with all types of planning, it’s easier to make adjustments sooner rather than later. Unfortunately, the U.S. Congress doesn’t have an excellent track record of making timely adjustments. There are some options available, though, and it’s unlikely that benefits will be reduced. Older people vote, and politicians want to take care of active voters. Another option is to increase the amount of taxable income. That’s highly likely as taxing the “rich” isn’t as unpopular as the other options. Or, increasing taxes higher than the current 6.2% is possible. Raising the full retirement age would be fairly likely. With life expectancy increasing, it will mainly be the younger generations who that change would impact.

While a lot has changed since Social Security was introduced, it’s important to understand what your benefit is and how you can optimize it. No one builds wealth by accident.

• Learn About Retirement Benefits | SSA
• The Silent Thief
• Investopedia: Sharper insight, better investing.

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Are you financially prepared for life after retirement? This episode of the One for the Money podcast is all about generating income in early retirement. Congress has put a 10% penalty for those who access IRAs before age 59 and a half, but I’ll be going over ways you can generate income. Listen through to the end, and I’ll share some early retirement tips, tricks, and strategies, including an easy math trick that allows you quickly to understand interest, rates of return, and how they impact both your investments and debts.

• The tricky first years of retirement [01:33]
• Retirement income sources [02:30]
• Workarounds to access retirement funds [04:41]
• The Rule of 72 [08:53]

The first few years of retirement can be the trickiest to generate income because Congress has applied a 10% penalty for Americans who access their retirement funds before age 59 and a half. The purpose of the penalty was to encourage Americans to keep their monies invested for longer to benefit from compounded interest. Consequently, it requires some deft planning to generate income during the first years of early retirement.

The simplest income source is savings, the money you have in the bank. Savings is money in addition to an emergency fund and should be the first money spent in early retirement because it just sits in the bank. I recommend that early retirees begin saving extra money in the bank in the few years just before early retirement. These savings will be the money you want to spend first, so it won’t be subject to risk in the stock market, where a downturn can reduce what you already have. Another income option is a non-retirement account, which is a great way to save more if you’ve already maxed out your retirement accounts. 

Roth IRA contributions are made with after-tax money. Because you have already paid taxes on this money, the IRS allows you to withdraw the contributed amounts, not the gains, at any time without taxes or penalties. For example, let’s say you contribute $5,000 to a Roth IRA in 2015, and it grows to $10,000. In 2020, you can take the $5,000 contribution out with no taxable consequences. However, the disadvantage is that less of your money will be compounding. So I wouldn’t recommend that you utilize the Roth IRA for funds in early retirement because you want this tax-free money to continue to grow as long as possible.

One of the most important things people can understand about finances is interest. Fortunately, a simple math trick called the Rule of 72 can help us understand how interest can impact our finances from both an investment and debt perspective. The Rule of 72 is a simple way to determine how long an investment will take to double, given a fixed annual rate of interest. All you need to do is divide the number 72 by the annual rate of return, and you will obtain a rough estimate of how many years it will take for your initial investment to double. The Rule of 72 is a powerful means for anyone to understand interest, which is integral to understanding finances.

• Amazon - 24 Year Stock Price History
• 72(t) Distributions

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This One for the Money podcast episode is all about the Financial Independence, Retire Early movement known as FIRE. I’m your host, Jonny West, and I’m going to be teaching you tips, tricks, and strategies you can use to retire early. We’ll also discuss Health Savings Accounts, which are a great way to save for healthcare expenses now and in retirement. I hope you’ll find this episode helpful for your retirement goals!

• Financial Independence, Retire Early [00:31]
• What to consider before early retirement [04:11]
• Health Savings Accounts [06:37]

Most of the people I know would never utter that phrase. Generally, the goal to work toward is the weekend, not going back to work. That’s why the notion of early retirement is appealing to so many. People want more time to do what they want to do. That’s why the Financial Independence, Retire Early (FIRE) movement is so popular.

The principal strategy behind this movement is being a super-saver. That typically means saving between 50% and 70% of income each year by having higher incomes and living frugally. To give some perspective, when planning to retire at age 65, I recommend clients save between 10% and 15% of their income each year into retirement accounts. FIRE adherents often save in non-retirement accounts because distributions occur before age 59½. 

After saving sufficient income, FIRE adherents retire from work and use their savings to generate income while continuing to live frugally. They can live off their income from portfolio gains, dividends, and interest without touching the original investment. After retirement, some people even move to less expensive locales so their retirement incomes can go further. 

Early retirement requires a lot of planning. My financial planning clientele consists of several early retirees and clients who are on track to do so. You may be surprised to hear that these people didn’t have significant incomes. Instead, they lived well within their means and invested the difference. My financial planning practice specializes in taking clients like these through early retirement and helping ensure that the next stage of life is just as meaningful.

Health Savings Accounts are the only investment that is triple tax-free. The contributions are tax-deductible. Both the growth and distributions are tax-free when used for qualifying medical expenses. To be eligible for an HSA, you must have a qualifying high deductible medical plan. The money in an HSA can be used at any time to cover health care expenses. But to see the full benefit, you’ll want to let the money grow and pay for current healthcare expenses from other sources of personal savings when possible. My younger listeners may think that they can wait until later. Remember, the sooner you invest your money, the longer it has time to grow. The average couple will need about $285,000 in retirement for medical expenses, not including long-term care. That’s a ton of money and is why you want to consider HSAs as a great way to save for future medical expenses.

• Mr. Money Mustache: Blog
• More Americans Want to Retire by 55. How Can FAs Help?
• Fidelity - 20th Annual Retiree Health Care Cost Estimate

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This is the inaugural episode of the One for the Money podcast! While most episodes will be about the details and implementation of early retirement, I want to take this opportunity to focus on the motivations and reasons. Many of you may be thinking that the “why” of early retirement seems straightforward. You’d love to stop working sooner! However, your retirement is far more successful when you retire TO something rather than FROM something. I look forward to sharing with you what that means, and at the end, I’ll share some early retirement tips, tricks, and strategies.

• The pursuit of happiness [01:59]
• Money management happiness [06:51]
• Which type of 401k is for you? [09:29]
• Having options in retirement [11:59]

You may be surprised to hear what research has shown about where people ultimately derive happiness. Studying happiness and the pursuit thereof has long been a hobby of mine. Much of what I read was research from Dr. Martin Seligman, an American psychologist who focuses on happiness rather than psychological disorders. He analyzed people who were thriving and derived five key elements of psychological well-being and happiness. These five core elements are positive emotion, engagement, relationships, meaning, and accomplishment: PERMA. Financial planning can help in each of these core elements. 

Financial planning is much more than managing money or helping you reduce your tax liability. It’s also about accountability to the values and goals that are most important to achieving happiness. Goals are the destinations, a financial plan is the vehicle to get us there, and investments are the engine that drives the plan forward. True financial planning will intensify these goals, designing and implementing strategies to help you on your way to PERMA and in your pursuit of happiness.

As you put together your financial plans, I challenge you to focus on the factors that impact happiness: positive emotion, engagement, relationships, meaning, and accomplishment. Those should be the central focus of any financial planning that you do.

There are essentially two types of retirement accounts. The difference between them is when you decide to be taxed. The first is known as the traditional retirement account. These are the original retirement accounts in which you elect to be taxed later when you retire. Traditional retirement accounts include an IRA version, 401(k), 403(b), and 457. The second type of account is a Roth retirement account, named after the senator who sponsored the legislation to create them. You elect to be taxed now in a Roth retirement account, so you never have to be taxed again. Roths are relatively new. They became an option as an IRA in 1998 and a 401(k) option in 2001.

The big question is: which should you choose? Your decision depends on what your taxes are now and what you think they will be in retirement. Tax rates may seem high right now, but they’re near historic lows. Starting in 2026, all the tax brackets, except the lowest, will be reset higher. As a general rule of thumb, it’s best to fund traditional IRAs and 401(k)s during your highest income years when your taxes are generally higher. It’s best to fund your Roth IRAs and 401(k)s during lower income years when your taxes are lower. Investing in both gives you a tax-diversified retirement with control over your tax rate. This strategy provides you with important options during your retirement.

• Start With 'Why' - TED Talk from Simon Sinek
• The PERMA Model: Your Scientific Theory of Happiness
• Flow: The Psychology of Optimal Experience (Harper Perennial Modern Classics)
• Mihaly Csikszentmihalyi
• Bank of America Study Finds Nearly Half of Affluent Americans Getting Their Financial Lives in Order During the Pandemic

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