As we approach the end of the 2018 year, I wanted to quickly go over some of the key concepts we’ve learned this year about savings and taxes. (I know this sounds boring, but I promise I will try to keep it concise and finish before you fall asleep)
One of the biggest concept I realized from all of the financial resources out there, was if you have the opportunity to take advantage of pre-tax savings/investments we should definitely try our best!
What does that even mean? Well for starters, most of us who work a “regular” job, that we get a W-2 at the end of the year, most likely have options from our employers to put our earnings into investments before taxes are taken out. Typically this is offered as a 401k or for government employees 403b. Basically, this means we have the opportunity to invest 10-30% more money and have that amount grow until we are ready to take it out, versus just paying that that 10-30% as taxes to the government that year.
Some background, I’ve always contributed to my 401k through my company ever since I’ve gotten a full time job. However, I’ve only been contributing the amount that the company will match (as a benefit of employment). My employer intially only matched up to 3% of my earnings if I was willing/able to contribute that much. For my situation that was am easy decision, why not take “free” money. So as a benefit of employment, most employers will give some kind of “match” with a “vesting” schedule. Vesting is basically how much of the “matched” contribution you can keep if you decide to the leave your current employer.
So I took a leap of faith this year after listening and researching into how to best take advantage of this pre-tax investment opportunity. Based on the 2018 tax bracket (provided below from the IRS website), I would personally would be taxed up to 24% on some of my income, which means a majority of my income and my wife’s income will be taxed at 22%. Let’s put this into some more relatable numbers, imagine that I earn $1,000 that will be taxed at 22%. That means I will pay in taxes $220 of that $1000 I earned. Once I understood that I was pretty frustrated…I thought to myself what can I do about this?!?!?!?
This is where utilizing the employer’s retirement investment option such as the 401k became very appealing to me. Long story short, I changed my contribution to my 401k from 3% of earned income to an amount that would allow me to get as close as I could to the current maximum 401k contribution limit of $18,500 (for 2018, it will be $19,000 in 2019). I am pleased to say that although I did not reach the limit, but I was able to contribute $17,806. I will definitely make it a goal of mine for 2019 to contribute the maximum amount of $19,000 into my 401k. To put this into perspective, if I had not elected to contribute $17,806 into this pre-tax savings account, I would have essentially paid ~$3,917 in federal taxes on those earnings.
That is definitely a simplistic overview of the situation but I believe it overall explains the main concept of how advantageous contributing to a 401k or any pre-tax investment account can be, when we simply look at how much we are saving that year in taxes. Beyond that we are getting to choose what to do with that money in the mean time until we get to pull that money out, of course there are more rules and regulations to how that money can be moved, used and taken out. (That is a whole book in itself) There are definitely a lot of options out there and some we haven’t even talked about in this post including 457, Traditional IRA, and Roth IRA accounts. If you want to learn a little more about that I did find a good overview in a table format to make it a little bit easier to understand. Savings account overview. <- we do not endorse the company that has put this material together but merely sharing because we found it to be very helpful, keep in mind that this information will change for the 2019 tax return.
So my take home message is, if you are financially able, consider placing your money in these beneficial pre-tax investment accounts and have the money you work so hard for, potentially earn you money!!! (Or you can just decide to pay thousands of dollars more in taxes)
Mr. Bzness, is in a completely different scenario, being that has a personal business venture. This means he doesn’t have the luxury of an employer having all of this 401k structure available to him. He is also convinced this is a great way to maximize his earnings as well (work smarter not harder, right?), so he is on his own journey to set up a solo 401k. Definitely be on the look out for this because once we get a little more traction on setting up a solo 401k, we will explain how the process was for him and give details on what we have learned about that journey.
Remember, “Work smarter not harder!”
Happy New Years to all!
Please let us know if you have any questions about anything in this post either in the comment section or through email.