Is it possible to pay zero in Federal Income taxes on a $150,000 income? The answer might surprise you.
The tax system in the United States might as well seem like a foreign language to most individuals. Vague statues. Obscure language. When you examine the tax system carefully it heavily favors those with higher incomes and those who invest. The investing part is not necessarily bad since Americans need to save more given the current state of the economy. I always wonder how many people understand all the complexities of the tax system to take advantage of every option available. The tax law and code is longer than the Bible. It is also rare to take advantage of all the tax benefits since few families actually have high incomes to maximize the return. If an individual makes more than $166,000 a year this will place them in the top 5 percent of income earners. Let us examine a family that has a gross income of $150,000 from their own business and see if we can get their Federal Income tax liability down to zero dollars.
The feasibility of zero in Federal Income tax on a $150,000 income
I remember reading an article early in 2011 about modifying your income via write offs, deductions, and investment vehicles on a $150,000 gross income and getting the Federal Income tax liability down to zero. I happened to find the printed paper with notes written all over the page. The page was a mess but I decided to put all the data into an easily readable format below:
*Click to enlarge
Now let us breakdown a few of the items above:
-$43,100 from self-employed 401k plus 20% company match. As a self-employed person you can contribute on both the employee and employer side of the equation at $16,500. You can also contribute another 20% of net income as a company match bringing the total to $43,100 that can be stashed away in the self-employed 401k. Keep in mind most individuals working for a company (which is the vast majority of Americans) will only be able to reduce their income by $16,500.
-$10,000 into Traditional IRAs. Keep in mind the above scenario has both spouses putting in $5,000 each into IRAs. Most investment books would recommend putting after tax income into a Roth IRA so it can grow at full potential and won’t be subject to taxes on withdrawals. We are using the Traditional IRA above to maximize the deductions for lowering the tax basis.
-$10,000 on mortgage interest. The home mortgage interest rate deduction is still a big line item for most households. The housing crisis has definitely put this into perspective for most given that the typical family is only pulling in $50,000 and not $150,000. So the maximum benefit is rarely realized in this case given the typically priced home of $150,000 but also a lower income base rarely utilizes all these other tax benefits to their full potential.
As you can see from the above data, it is possible to reduce the Federal Income tax liability to zero on a gross income of $150,000. I remind readers that the typical US household makes $50,000 a year so realistically there is only so much they can take advantage of. At this level, many families are spending a substantial portion of their net income on housing, fuel, food, college, and other daily cost expenses.
Yet as you can see above, the major deductions that drove income the lowest were favoring those that invest. The self-employed 401k and IRAs alone reduced the tax liability by $53,100 (or more than the typical household makes).
I would be really curious to see the breakdown of how many families claim each deduction and at what income levels. The above scenario on a $150,000 income demonstrates the ability for individuals to lower their tax basis via many write offs, deductions, and expenses. The complexity of the system and overall lower household incomes make scenarios like the above rare cases but possible nonetheless.
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Learning how to retire like a millionaire with $250,000. It is possible but you need to hack your idea that $1 million is the minimum to retire.
Many Americans have a magical notion that $1 million is sufficient for a steady retirement. Let us not point out that most Americans, 75 percent have less than $75,000 to their name and over 30 percent have zero dollars to their name. This by no means is a secure retirement. But lifestyle hacking is possible. The reason $1 million is thrown out is that many feel they can drop down $40,000 a year from the fund and go on once the job income stops coming in. Yet extreme times call for extreme measures. Many are realizing that overly zealous stock market returns and stumbling wages are putting a dent to already meager retirement funds. So can someone retire on $250,000 and still have the lifestyle of a $1 million retiree?
Retirement is more of a concept
The entire idea that retirement is filled with non-stop golf playing and daiquiris on some Caribbean island is a modern day topic. In the past, most people worked until they couldn’t. Part of life is being productive in various ways that suit your age. Many research articles have pointed out how many people once they reach retirement see a decline in their health (aka they die). If you give 30 or more years to working and this was your identity, there has to be something to fill the place up. The $1 million figure is actually a stock seller marketing ploy. Why do you even need $1 million? As the stats point out, 75 percent barely even have $75,000. It probably would make better sense to work with what we got.
With $250,000 someone can pull $12,500 per year for 20 years. Couple this with Social Security and you are looking at roughly $2,000 a month for spending. There are many low cost areas of the US where this can go further since you are not tied down to a city. Look outside the US and you have countries like Thailand where your dollar will go very far.
Flexibility is the key and you have to be nimble when you think of retirement. Your big costs are housing and healthcare. Most large metro areas in the US are notoriously expensive for both of these items. So if you are constrained on both these spending areas, you need to think outside of the box. And by outside the box, I mean not where you currently live. Times change. Economies evolve. Boom and bust. $250,000 puts you in the top 25 percent of US households in terms of net worth.
I think the idea of $1 million nest eggs is largely a dream for most and the statistics unfortunately highlight this. To live like a millionaire in most metro areas will actually require you to be, well, a millionaire. If you can lower housing and healthcare costs by leveraging location, you are better set to live a comfortable life. Of course this option seems so remote to most that they rather hold on to the idea that $1 million is the absolute minimum for a secure retirement. When this is not met, which most do not meet, they feel like they have somehow failed. That is not the case. Like I mentioned before, in many parts of the world, people work largely until they can’t.
We need to redefine retirement and not go by a bunch of marketing ads that show falsely happy people on exotic vacations blowing money they don’t even have.
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Don`t let your credit card control you
It is not uncommon to have some type of credit card debt. Many people carry a balance every month on their credit cards while others are making only the minimum payments to get by. In these situations, the credit card is in control. It requires payment regularly. To get it off your back, you need to either pay larger amounts each month or set up a balance transfer.
With a transfer, if you’re not careful and continue with the same spending habits, you could be continuing to let debt control you. Check out these tips for gaining or maintaining control over your credit card.
Make Sure You Have the Right Credit Card
Check your current credit cards. Cards with higher interest rates and higher fees tend to be more difficult to control. If you’re not paying off your balance each month (or at least within six months), the compounding interest starts to become a problem. Your balance continues to rise and eventually, you are making only the minimum payments to try to keep the card current. It doesn’t matter whether you are getting rewards, gift cards, or even airline miles; the costs far exceed the benefits. It is time to look for a new credit card.
If you have a card that is difficult to control, consider a balance transfer. Many credit cards offer a reduced interest rate as an incentive for potential customers to switch over from another company. This is a great opportunity to take advantage of the lower interest rate and pay off as much of the card as possible. Be aware that these lower rates usually don’t last long. Plan to make the largest payments possible, to decrease your balance, while you have the chance.
Use Your Credit Card Wisely
Decide how much you are going to spend, using the credit card, each month. Can you pay off the balance at the end of that time? If you can’t, you are overspending and eventually, the credit card will be in control. Keeping track of what you charge and making a payment to cover those charges is the best way to stay on top of your credit card.
If you are still trying to regain control of your credit card, the goal is to stop spending and make payments until you have a zero balance. From there, you can establish new habits that ensure that you stay in control of your credit. With a clean slate, you have the opportunity to start over and make better decisions.
Finally, make sure that you monitor your credit card spending at all times. Don’t skip over opening a credit card bill. Keep an eye on the balance you owe, the interest rate and any charges added on by the credit card company. If you start to notice that things aren’t going well with the credit card, consider a balance transfer to a credit card company with a promotional interest rate. From there, you can make sure that your credit card doesn’t ever control you again.
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