Stealthy, Healthy, Wealth

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In a utopian America as I would construct it, every day, every week, and every month would pass, with each of us not hungering for our next purchase.

Instead we would regularly inspect our own lives much as a corporate raider inspects a company he has just taken over.

We would fiendishly chuckle while looking for the next chunk of fat to slice and discard.

We would relentlessly pare down  that which was not needed in order to build up our precious financial reserves.

Sure, our inner infant might cry like a laid off steelworker. But we would just chuckle to ourselves and repeat the soothing mantra “creative destruction,” over and over again.

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Ideal citizen in a Dividendian Utopia

In short, we would be a country of over 350 million Mitt Romney’s (without the car elevators.)

The end result, of course, would be that everyone’s savings rates would skyrocket.

(Sure GDP would go down each and every year, but who cares, we’d each have more than enough money to each be financially independent by age 30. And do you know what else would go down? Greenhouse gases!)

The point of this post, however, is not to launch a new economic theory, or to establish my bona fides as a great humanitarian.

No the the point is simply this: if you start focusing on your own financial independence now and pick up your savings rate you’ll soon find yourself with a new and welcome problem.

You’re going to have a growing amount of savings that you are going to have to figure out what to do with.

And the answer to this problem brings us back to Romney.

In fact I would suggest that you make a rare exception here and ignore your newly minted frugal tendencies in order to preorder one of my soon to be released Miles-Dividend-M.D.-Approved-Charm-Bracelets.

Emblazoned upon each bracelet will be a simple and tasteful anagram in a staid old English font.

WWMD

What would Mitt do?

And the answer is as obvious as it is important: avoid taxes.

Which is to say that the effect of taxes on your retirement savings rate cannot be overstated.

Just as small changes in expense ratios can dramatically impact your ability to accumulate wealth, (due to the exponential growth of compound interest) so too can taxes.

Only more so. You see the gap between an expensive mutual fund and a cheap one is generally a 1-2% per year difference in the expense ratios.

But the difference between an untaxed dollar, and one that is taxed at the lowest marginal tax rate is 10% (assuming no state taxes.) And it only goes up from there.

So what would Mitt do?

He would put every saved dollar into a tax-advantaged account before putting a single dollar in a taxable account.

And it would look something like this:

Step one: maximize 401(k) account contributions.

Step two: maximize IRA contributions. (or better yet backdoor Roth IRA contributions.)

Step three: maximize HSA account contributions.

Which brings us around to the whole raisin d’aitre for this blog post.

The Health Savings Account, otherwise known as the stealth IRA, is a clever way to add more tax-free earnings to your retirement accounts each and every year.

What is the HSA? It is retirement account masquerading as a health expense account.

This is the way it works.

You sign up for a high deductible health care plan.

You then fund an HSA account up to its yearly maximum ($6500 per family in 2014) and invest the money.

This $6500 is then completely tax-sheltered. Not only is it deducted from your income like a traditional IRA contribution, but it is exempt from all FICA taxes.

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Excellent…

Then whenever you have medical expenses you can either;

A. Pay for them with money from your HSA account with pretax dollars, or

B. (Even better) Pay out-of-pocket (with a miles earning credit card no doubt) and pull that amount of money out tax free whenever you want, at any time in the future.

In other words, every dollar of medical expenses in scenario B becomes the equivalent of a Roth IRA contribution only better, (the original contribution was made with pretax dollars and you can pull the principle out whenever you want.)

And what if you’re exceptionally healthy and have no medical expenses? Never fear, just pull the money out like a traditional IRA withdrawal after age 65. There will be no penalty. It will just be taxed as income like a traditional IRA.

It is quite simply a way for one percenters (like me) or super savers (guilty again) to sock away more of their money out of the reach of Uncle Sam. (Which I think is precisely what Republicans are referring to whenever they say “a free-market solution.”)

Now I’m not saying this is fair.

And I’m not saying it’s right.

(I favor a progressive tax system that treats every dollar of income the same with lower rates for all and no deductions.)

What I am saying, however, is this. This is the system we are in, and we might as will take advantage of it to turbocharge our savings rates and move us ever closer to our worthy goal of financial independence.

After all, as a famous Industrialist once said “When life gives you Perrier, make wine spritzers.”

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One Response to “Stealthy, Healthy, Wealth”

  1. Robert January 19, 2014 at 12:50 pm #

    Doc, for those in middle to upper income categories who are aggressively saving for retirement, there is another advantage to ROTH IRAs that shouldn’t be underestimated–no required Age 70-1/2 minimum distribution. If you have your spending under control, and you plan to retire with no debt (including home mortgage paid off), your annual budget needs can be pretty modest. Imagine being forced to withdraw money and pay taxes on it? And worse, suppose that you have saved enough that the size of those mandatory withdrawals puts you over the limits and now some of your Social Security benefits are reduced/taxed? That could be your future if you don’t manage your tax-deferred savings wisely.

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