Monday, February 21, 2022

It Pays To Be Poor!

The standard deduction is about $25,000.  Earn more than that, and pay 10% or more in taxes!

In 2020, our income was pretty low.  A flood in the condo meant that our tenant didn't pay rent for three months. As a result, our rental income was a paltry $1000 for the year.  In addition, I had only withdrawn $25,000 from my 401(k) which in addition to some miscellaneous income meant that our overall income was about $28,000 for the year.  After the standard deduction (and business deduction) we ended up paying a few hundred in taxes.

For 2021, our income went up by $8,232 as our tenant paid rent all year, earning us $5000 from rental income (that is to say, net profit after expenses - overall rent was over $15,000).  In addition, I took $30,000 out of our 401(k).  As a result, our Federal taxes increased by $735 and our Georgia state tax increased by $473 for a total of $1208 in increased taxes on an $8232 increase in income. That's like a marginal rate of 14%!

Granted, this is still lower than the marginal rates paid by most working people.  We are in the 10% bracket, which is a nice place to be, after you put all that money in the 401(k) when you were working and in the 35% bracket (plus State!).

I had money left over in my after-tax savings account last year, so it wasn't like I needed to take $30,000 out of my 401(k) - the excess money was "wasted" in a matter of speaking, on excess taxes. On the other hand, I suppose I need to build-up my after-tax nest egg for that new roof or new driveway or other "emergency" need that might arise.  If I had to take all that money out in one year, it might boost me into a higher bracket.

Of course, people are puzzled as to how we live so well on so little (the mantra of this blog - no?) and the answer is, no debt.  It costs us about $1000 a month to pay for the house expenses (property taxes, utilities, minor repairs) and since we have no car payments, no mortgage payments, no credit card debt, no student loan debt, we can live on fairly little, in terms of annual income.  To most folks older than I am, the idea of being debt-free is alien - they all have pensions, car payments, and mortgages.  The 401(k) generation doesn't have that luxury.  Well, some do, but it is a good way to squander your income, paying it all to banks and paying higher taxes as well.  If we had to pull out another $24,000 a year out of our 401(k) to service a mortgage, well, it would push us into a higher tax bracket, which means we'd have to take out even more to pay the taxes - and more to pay the taxes on the more we took out to pay the taxes on the more we took out to pay the mortgage interest to the bank!

(It reminds me of when Oprah gave away Pontiacs to homeless people.  Suddenly, they had an income tax problem on a $25,000 car.  So Oprah gave them money to pay the taxes.  Fine.  Now they needed yet more money to pay the taxes on the money she gave them to pay the taxes on the car.  So she gives them that.  Now they need money to pay the taxes on the money she gave to pay the taxes on the car.  It is like a calculus equation - you can calculate the amount you need, it is a derivative!).

Debt-free is the way to be.  Sure, I could "make more" in the stock market - maybe.  But by not paying $2000 a month in mortgage interest to the bank, it is like earning $2000 a month in the most stable risk-free investment of all time.  Add in the tax savings and, well, you may be beating the stock market much of the time.

Of course, this only works when you are retired and taking money out of a 401(k). When you are younger, you have a huge income (let's hope) doing computer thingies and have a huge mortgage to service because you don't have a half-million in cash laying around to buy a house with.   You seek out those deductions - the IRA and 401(k) and mortgage interest - to reduce your tax bill. If you are really clever, the depreciation deduction on income property may help even further.  Sadly, we've fully depreciated our last remaining income property and only have Capital Gains tax to look forward to - but there are ways of avoiding even that!

But if you can work toward paying down and paying off that debt, when you retire, well, you are sitting in the proverbial catbird seat.  I'm not saying you have to live on $30,000 a year - that is something I choose to do (quite frankly, as I noted above, I am having trouble spending even that - but this too, shall change).  But the less you have to pull from your 401(k) the better off you are, in terms of tax bills.

And that was the whole bleeding point of the IRA and 401(k) - you pay in during a time in your life when your tax rate is 25% or more and avoid taxes on that money.  Take it out at a time in your life when your tax rate is 10-15% or less.  Cheat the tax man - legally!

What makes no sense is taking money out of your 401(k) and paying 30% or more in taxes - sometimes more than what you were paying when you were working.  And yet some people do just that.  Probably shoulda had a Roth IRA instead, I guess.

I already took out $30,000 from my 401(k) (which is actually a rollover IRA at this point) for 2022.  In retrospect, I should have done this in tranches (a trendy word, no?) and thus limited my tax bill in 2023.  Worse yet, I may lose my phone subsidy next year!

Now I just need to figure out how to get that big slab of gubment chee...