Uncle Sam Incentivizes You To Make Less Income

Chasing A Lower Income Makes Sense At A Point In Your Career

 

If you make $250k a year through employment you get very few tax incentives. You can likely deduct $18k which you would stash away in a 401(k). Then you get a little break in the form of a personal exemption and you may either take a standard deduction or tally up your receipts for an itemized deduction. Your tax rate would be something absurd… you’ll get to keep maybe 60% of it… not taking into account all the extra expenses associated with living a lifestyle built around a full-time job.

In the below calculation you can see that a gross income of $250k is taxed at $232k after deducting the $18k that’s contributed to a 401(k). It’s a rough estimate of taxes but you will owe somewhere around $90k to Uncle Sam for Federal and State (Oregon) income taxes. 

250k gross income income tax scenario

What if you only made $60k. You could still put away $18k in a 401(k) if employed or into a solo 401(k) if self-employed. That would leave you with only $42k of taxable wages. You could even contribute to a deductible IRA at that point and lower that income by another $5k. In the below calculation you can see that $42k of gross income would be taxed at around 25%, you would keep more than 75% of your money.

40k gross income tax payroll example and state federal

 

At this lower income other tax breaks suddenly become available to you which disappear for those who make above the cut-off (actually you get penalized with higher medicare taxes). For example, you can deduct your student loan interest payments at lower income levels. With a few more deductions from your gross income you may even qualify for lower health insurance premiums.

This strategy of lowering your income may not be a viable option if you have a ton of student loan debt left. But once you start making a significant dent in that debt and you stash $100-200k away you could take advantage of working less, keeping more of your income, still having your savings grow and getting tax breaks.

Imagine working just a few hours a month with a ton of free time. You could even continue to contribute $18k per year to your 401(k) while working in this fashion. With your $200k invested and paid off student loans you would have nearly $2 million after 25 years. And if you didn’t invest another nickel then you would have nearly $900k. Remember, money invested in broad index funds continues to grow and generally outpaces inflation over the long-run.

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