The Simple Way to Get Rich and Avoid Taxes (And Not Go to Jail)

Get rich or die trying.—50 Cent

Loopholes weren’t meant to be broken but utilized. How do the rich stay rich? By knowing how to use tax laws and resources to their advantage. Here are some vehicles for you to start.

Let assume, for simplicity, you just turned 30. You have no debts and no savings. You just started a new job paying you $100,000 a year. Not a bad life. But let’s look at how we can bring home more money by reducing our tax burden.

Get Rich or Die Trying: 401K

Your new company has a 401K program.

If you don’t take part in the 401K program, your salary is still $100,000. In 2020, the 24% tax bracket is for income from $85,526-$163,300. Tax brackets are complicated, so we will again make an assumption that will make things simple. Let’s say you pay federal taxes of 24% on your income. (This is not how marginal tax rates work, for more info, read here)

Your $100,000 salary is now $76,000 after taxes.

Let’s assume you do decide to utilize your companies 401K plan. In this example, for each 1% you contribute, they match 1%, up to 3%. For each 1% you contribute from 4 – 6%, they match at .5%. So if you contribute 6% of your salary, $6,000, to your 401K, your company also contributes $4,500. The first $3,000 you contribute, they contribute $3,000 as well. And the next $3,000 you contribute, they contribute $1,500.

The money that you put into a 401K is money that is not taxed. It is put into your account before it is taxed. So contributing lowers your taxes. If you put $6,000 into your 401K, your pay that is available to be taxed is $94,000. Taxed at 24%, you take home $71,440.

So between the $6,000 and $71,440 you walk away with $77,440. That’s $1,600 more than the $76,000 if you did not contribute anything. But there is also the money your company contributed, $4,500. So you now have $81,940. Just by putting 6% of your salary in a 401K, you now have $5,940 more than if you didn’t use a 401K.

Plus this money is invested, usually by a third party, so it will grow over time for you.

Get Rich or Die Trying: Roth IRA

The next thing you should do with your money is put it in a Roth IRA. Money put into the Roth needs to be money that is already taxed. So, (using the previous example where you contributed to your 401K) it will be from the $71,440. You can put up to $6,000 in your Roth a year (as of 2020).

If put $6,000 in a Roth in 2020 and invest in the market (we assume 8% growth each year) by 2050 you would have $60,376.

Let’s say you put that money in a regular investment account, not a Roth. You’d still have $60,376 by 2050.

The difference is how it gets taxed when you withdraw the money. For most people, the capital gains tax is 15%.

With a Roth, you do not have to pay that tax, with pretty much any other account you do. In this case, the $60,376 you have in your “regular investment account”, becomes $51,319 when you withdraw it and pay the 15% capital gains tax. That is a difference of $9,056 going straight from your Chipotle funds to Uncle Sam.

Get Rich or Die Trying: Contribute to your Roth IRA Every Year

Now to get you even more excited, let’s assume you put $6,000 in your Roth every year from ages 30 – 60 and it grows again at 8% a year. Over 30 years you would have put $180,000 into your Roth. But your account would be worth $740,075 (assuming contributions are made at the end of each period.) Compounding interest is a beauty!

So now you have $740,075 and retire. In a Roth, you withdraw that money, clean and simple. With a “regular investment account”, that money faces a capital gains tax (let’s assume 15% again). You walk away with $629,064. That is $111,011 you are losing.

Look at how huge those differences are.

That’s YEARS of extra guac at Chipotle you can be missing out on.

Get Rich or Die Trying: Feed your 401K as Much as Possible

So now you put 6% in 401K and $6,000 in your Roth, if you’re feeling dangerous, put more in your 401K. The most (for the majority of people) you can put in a 401K a year is $19,000.

In this example of a $100,000 salary, you contribute 19% ($19,000) to your 401K.

Your taxable income is now $81,000. Congratulations you just moved down to the 22% federal tax bracket (again for a better understanding of federal taxation, read here). Your taxes are $17,820. Your take-home pay is $63,180, of which you would contribute $6,000 of that to your Roth.

You also have the $19,000 in your 401K from you and $4,500 from your company. A total of $23,500.

Your take-home pay and 401K contributions total $86,680. You just saved yourself $10,000 compared to not contributing to a 401K at all (remember the $76,00 before). Go celebrate with a Natty Light, you don’t want to spend all those savings in one place.

Final Thoughts

It’s tough trying to save for so far in the future. But put in the hard work now and you will reap the benefits when you’re older.

And remember: If it doesn’t hurt, you aren’t saving enough.