I didn’t work a full-time job this year. And in less than a few hours of work, I have close to $100K of income. But how’s that possible?
Since I didn’t work this year, I would have been in a lower tax bracket. So, I moved some savings to pay more taxes this year…
That sounds bad, right? Why pay more in taxes?
For the short answer, I’ll pay much less to Uncle Sam down the road. And I’m taking advantage of other tax benefits today. I’ll show you exactly what I’m doing with my money.
When it comes to building wealth, reducing your taxes has a huge impact. And planning for the long-term changes the game. Small moves can compound your savings to an extra half a million dollars or more.
I’m sharing this personal story because I know it can help many people. There are many guides online, but few real examples. It’s hard to trust faceless websites and articles (check out my YouTube channel if you want to get to know me). For most people, it’s taboo to talk about your income and savings. But I’m not most people 😊 Here’s how I’m reporting $100K without working this year…
Boosting My Income to Pay Taxes
This year, I converted $93,269 in a traditional 401k to a Roth account. That means I’ll report that amount as taxable income. On top of that, I have some freelance, YouTube, dividend and interest income.
Let’s round the amount to $100K to see how this works…
First, I’ll subtract the standard deduction of $13,850 and that leaves me with $86,150. From there, let’s plug it into the tax brackets to see what I owe…
| Tax Rate | Single Filers | My Taxes |
| 10% | $0 to $11,000 | $1,100 |
| 12% | $11,000 to $44,725 | $4,047 |
| 22% | $44,725 to $95,375 | $9,114 |
My marginal tax bracket is 22% and my total taxes would be $14,262. At this point, my effective tax rate would be 14% ( $14,262 ÷ $100,000 ).
However, I should pay less in taxes for the year. Here are a few more ways I’m lowering my taxes…
How I’m Paying Less in Taxes
Since I bought a new Tesla at the start of the year, I have a $7,500 tax credit. And early on, I found out that it’s a use-it-or-lose-it credit. It’s nonrefundable and won’t carry forward to future years. That played into why I converted so much to a Roth account.
Tax credits lower your taxes dollar for dollar. So, instead of owing $14,262, I can knock it down to $6,762 and that brings me to below a 7% effective tax rate. However, I plan to pay even less… legally of course!
No one should pay more taxes than they’re legally required. Tax evasion is illegal, but tax avoidance is not…
To further lower my taxable income, I have business expenses to offset my freelance and YouTube income. On top of that, I might reduce my taxes by selling investments with capital losses before the end of the year. If you’re following suit, avoid the wash-sale rule. That means you can’t report the losses (to reduce taxes) if buying the same investment 30 days before or after the sale.
Good thing the wash sale rule doesn’t work in reverse. You can move gains forward to pay taxes sooner. You can sell an asset and buy it right back. This bumps up your cost basis and it’s best to do if you think you’ll pay less in taxes today than in future years. This logic is one reason I converted to a Roth 401K.
Benefits of a Roth Conversion
With reporting $100K, I’ll still have a low effective tax rate. That’s thanks to the moves I mentioned above. If I worked full-time, I’d likely pass on the Roth conversion due to being in a higher tax bracket.
When you’re in a lower income year, you might want to consider a Roth conversion. Although, you’ll want to make sure you have other savings to cover your living expenses and taxes. That’s a big caveat. Plan your cash flows and it’s good to have an emergency fund.
Another benefit of converting to a Roth is more flexibility down the road. Unlike traditional retirement accounts, you won’t have required minimum distributions (RMDs). You won’t be forced to take money out and pay taxes (or pay a penalty). After reaching retirement age, all withdrawals should be tax-free.
More Ideas to Improve Your Roth Strategy
I could have optimized to pay zero taxes this year. However, I wasn’t sure on what my exact income would be. Also, paying a small amount will still lead to big long-term tax savings.
Here are some other ideas I considered…
- Roth Conversion Timing Within the Year
- Since I didn’t plan to work, I did the Roth conversion in the first half of the year. Since then, it’s up roughly $15,000. That’s an extra $15,000 (and compounding growth), I won’t be taxed on.
- Historically Low Tax Rates in the U.S.
- Considering national debt and other (underfunded) programs, I wouldn’t be surprised to see higher tax rates in the decades ahead.
- Moved to a State Without Income Tax
- Before the year started, I moved to South Dakota. It’s been my home base while traveling across the country. Fewer than 10 states don’t have income taxes.
- No FICA Taxes on Roth Conversions
- Since I paid (and my past employer paid) these payroll taxes, I wouldn’t have to pay them again with a Roth conversion.
- Plan for Your Tax Payments
- As mentioned, if you’re doing a Roth conversion, make sure you have the income or savings to cover any extra taxes for the year.
- Avoid RMDs
- Also as mentioned above, no RMDs down the road. This gives more financial flexibility during retirement.
- Simplifying My Fidelity Account
- When I initially contributed to my work Fidelity 401K, I started with Roth contributions. I was in a lower tax bracket at the start of my career. However, I learned to add more value and jumped tax brackets. So, I switched to traditional contributions. However, Fidelity grouped them together and I couldn’t specify what investments went where. I reached out multiple times and the best answer I got was they’d weight the investments for me based on past contributions. By converting all the traditional portion to Roth, I’ll avoid a headache down the road.
- The only reason I’m sticking with Fidelity is they were the only big brokerage that offered a free HSA account (I transferred from my past work HSA provider that charged fees).
- Roth Conversion Money is Still Locked Up
- Although I’m reporting $100K in income this year, I can’t touch most of it until I hit retirement age. Otherwise, I’d pay a penalty for early withdrawal. Retirement age is also a moving goal post, along with increasing life expectancy.
Small decisions today compound. A little tax planning goes a long way. That’s why I’m sharing what I’m doing with my money. There are many ways to save…
Another way I’ve kept costs low is by finding free Tesla charging. If you haven’t bought an EV, that will likely change down the road. I take an objective approach to the markets. I’ve invested in both oil and new technologies. I’m good with cutting through the headlines and instead, following the trendlines 📈
I hope you’ll stop by my blog again or YouTube channel. Please comment on any of my videos if you have questions. Or I always appreciate a simple hello 😊 It motivates me to keep sharing my research.