I Hate Paying Taxes

Photo credit: B Rosen

I can be something of an ideological nut job when it comes to avoiding income taxes. In my younger days, before my wife dragged me kicking and screaming into normal, civilized behavior, I was known to subsist on rice and beans for a month or two at a time in order to free up cash to max out my 401k plan, Roth IRA, HSA plan and any other tax-free savings vehicle I could get my hands on. Yes, it was Spartan. But it saved me a ton in taxes over the years, and I’m still enjoying those benefits more than a decade later.

Don’t worry, I’m not going to recommend you go to my ridiculous lengths. My pathological need to lower my tax bill is probably an unhealthy obsessive-compulsive disorder. But with the tax return deadline coming up on Monday, I figure a little advice on prioritizing is in order. It might be too late to put any of this into practice for your 2015 return. But you can absolutely make a dent in your 2016 tax bill. So, with no more ado, here are a few tips for lowering your tax bill this year.

It starts with the 401k. Before you invest a single red cent in anything else, you should come as close as you reasonably can to maxing out your 401k plan. In 2016, that maximum contribution level is $18,000. If you’re young, that might not be realistic goal. For some recent graduates, $18,000 might very well amount to nearly half their after-tax income. But if maxing out the 401k isn’t doable, then you should at least contribute enough to take full advantage of your employer’s matching, which usually amounts to 3%-5% of your income.

If I had an employee under me that didn’t contribute at least enough to get full employer matching, I would find an excuse to fire them. Employer matching is an instant, tax-free, 100% return. If you’re not smart enough to take advantage of instant 100% returns, you clearly don’t deserve your job.

Once you max out the 401k plan, look into contributing to a Roth IRA. (A Traditional IRA is usually not tax deductible if you’re already contributing to a 401k plan, so a Roth is going to make more sense.) A single taxpayer can contribute the $5,500 per year to a Roth IRA ($6,500 if 50 or older) so long as their income is no more than $117,000 per year. At higher income levels, the amount of money you can contribute to a Roth IRA starts to get phased out and goes to zero at an income of $132,000. For married couples filing jointly, your eligibility starts to be phased out at $184,000 and falls to zero at $194,000.

If you make too much money to contribute to a Roth IRA… well, congratulations! That’s a great problem to have. But it’s still a problem.

Luckily, there is a loophole. For those willing to do a little extra work, you can open a traditional IRA and then convert it into a Roth IRA.

Ok, let’s say you’ve maxed out all 401k and IRA options. What next?

If you have a high-deductible health insurance plan, consider using a Health Savings Account (“HSA”) as an “extra” IRA.

HSA accounts are intended to be used for health expenses. But no one ever said you have to spend the money. You can let the money sit in an HSA investment account until age 65, at which point you can withdraw it penalty free just as you could with IRA funds. Note: There are differences here. You can withdraw IRA funds penalty free at age 59 ½. With HSAs, you have to wait that additional 5 ½ years to age 65 in order to use the funds penalty-free for non-health-related reasons. Though you can withdraw the funds penalty-free and tax-free at any time so long as you use them for medical expenses.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.