![\"\"\/](\"https:\/\/moneywithkatie.com\/wp-content\/uploads\/2021\/03\/image-asset-3.webp\")
<\/p>\n<\/p>\n
If you can\u2019t beat \u2018em, evade taxes like \u2018em. <\/p>\n
Just kidding \u2013 there will be no tax evasion here (you hear that, little FBI man that resides in my MacBook Air? No need to call Jim at the IRS, because everything in this post has its origins in tax code loopholes, laws, and cultural differences between the wealthy and the middle class)<\/em>.<\/p>\n I think it\u2019s very much worth calling out: I am middle class. I was raised middle class, I make a middle class income, and I don\u2019t consider myself \u201cwealthy\u201d in the sense that I\u2019m talking about \u201cthe rich\u201d here. However<\/em>: I\u2019d rather model my financial behavior after people with two commas in their net worths instead of one.<\/p>\n Good question! Here\u2019s the thing to understand right off the bat about taxes:<\/p>\n Your earned income and your property are the two things that are taxed the most aggressively. <\/p>\n Read that again.<\/p>\n Your earned income<\/strong> and your property<\/strong> are the two things that are taxed the most aggressively. <\/p>\n What do middle class people have in common? <\/p>\n Well, usually, they have good, middle class jobs (that pay earned income<\/strong>) and a primary residence (that faces unforgiving property taxes <\/strong>every year). <\/p>\n (Property taxes are the thing that everyone likes to ignore when making the argument that home ownership is an unquestionably good idea. At a national average of 1% of the value of your property every single year<\/em>, your $350,000 home has an additional (average) $3,500 expense tacked on to its mortgage, interest, and insurance annually that goes toward nothing but Uncle Sam. Puke! The more expensive your home, the more you owe to the government. It\u2019s one of the most effective ways to actually tax the wealthy, because you can\u2019t move your home to an offshore bank account.)<\/p>\n Now, there\u2019s nothing wrong<\/em> with owning a home (see the \u201cCars & homes\u201d category on this site for more articles about the math of home ownership), but the hard thing about the middle class is that 80% of middle class Americans have <\/em>the majority of their net worth<\/em><\/strong> (60%) tied up in their home<\/em><\/a>,<\/em> which means most of their net worth is taxed over and over and over again on an ongoing, never-ending basis. <\/p>\n Conversely, the upper-middle class and \u201cwealthy\u201d in America (the demographic we\u2019re attempting to model our financial habits after) own homes that account for only between 10 and 30% of their total net worth.<\/p>\n So what\u2019s taxed un-aggressively? <\/p>\n Is un-aggressively a word? It keeps generating that ugly red line underneath it, but I\u2019m plowing forward for the sake of the narrative.<\/p>\n You know what\u2019s taxed at an almost laughably low rate?<\/p>\n Your long-term capital gains<\/strong> and your dividends<\/strong> \u2013 that is to say, any money that your money makes for you (in an investment account) is taxed so little it\u2019s almost a joke. Let\u2019s dive deeper.<\/p>\n Historically, the middle class in America has put most of their net worth into their homes. And you know what? It\u2019s not their fault: We\u2019ve all been sold a lie that home ownership is the way you get rich (it\u2019s not). To understand why, check out this post<\/a> about when the math actually supports buying instead of renting.<\/p>\n But what happens if my entire net worth (or close to it) is \u201cinvested\u201d in my primary residence? <\/p>\n Let\u2019s say my primary residence is worth $500,000 and I have about $25,000 in cash. My total net worth is $525,000, assuming I own the home outright and no longer owe any payments on it. <\/p>\n Let\u2019s also pretend that my income is $125,000 per year. Because I like nice things, I don\u2019t really invest any of the money \u2013 I just take it all as cold, hard cash, spend most of it, and shuffle whatever\u2019s left over into that $25,000 cash sitting in my savings account on the side. <\/p>\n If you\u2019re looking at this scenario thinking, \u201cHey, that\u2019s not so bad! Half-a-million-dollar home, $25,000 in cash, and a six-figure salary? I\u2019d take it.\u201d <\/p>\n My friends, this person is a tax NIGHTMARE!<\/p>\n Let\u2019s explore why:<\/p>\n Assuming they pay the national average in taxes on their $500,000 home, they\u2019re looking at a $5,000<\/strong> property tax bill annually.<\/p>\n<\/li>\n Their earned income, $125,000, is their only source of income \u2013 in other words, they\u2019re only living on earned income \u2013 no capital gains or dividends to speak of. This person would be taxed on the full $125,000, paying $29,101<\/strong> in federal income taxes and FICA (want to calculate your own? I\u2019m using this calculator<\/a>). <\/p>\n<\/li>\n<\/ul>\n Our hypothetical middle classer is paying nearly $29,000 in taxes this year \u2013 more than the amount they\u2019ve got in their savings account liquid. They\u2019re technically \u201cworth\u201d over half a million dollars, but they can\u2019t use their home to pay their income taxes.<\/p>\n Investing is beneficial for your tax liability (in other words, it can help shield you from taxes) in two ways:<\/p>\n When you invest in a pre-tax account, you shield that money from Uncle Sam\u2019s bill collectors because you\u2019re \u201cdeferring\u201d the taxes for a later date (but if you\u2019re a loyal Money with Katie reader, you know you can also collect it later tax-free too if you perform the Roth IRA conversion ladder<\/a> and keep your conversions under the standard deduction<\/a>). <\/p>\n<\/li>\n When you get to the point where you can live off investment income (i.e., invest aggressively enough for long enough), you can \u201cpay\u201d yourself a ridiculously high amount before the money is actually taxed. <\/p>\n<\/li>\n<\/ul>\n Let\u2019s break this down. <\/p>\n First, it\u2019s helpful to look at the tax brackets on earned income:<\/p>\n<\/div>\n As we can see here, our friend is being taxed in the 24% tax bracket on the last $20,000 he or she makes. Of course, the standard deduction will eat up some of that \u2013 but the point stands that they aren\u2019t doing much to help themselves lower their tax liability. <\/p>\n (The earned income tax brackets are progressive, which means your income is taxed at different rates. Your first $10,000ish is taxed at 10%, the next $35,000ish is taxed at 12%, etc. \u2013 which means the person\u2019s entire<\/em> income isn\u2019t taxed at 24%, only the chunk from $103,350 to $125,000.)<\/p>\n Pretty gnarly, huh? But what if this person had been investing in the market for the last 15 years? <\/p>\n Better yet, what if this person had avoided the half-a-million-dollar McMansion and instead invested heavily<\/em> in low-cost, diversified index funds that were now producing dividends and capital gains this person could live on<\/em>? (In other words, what if they were nearing financial independence?)<\/p>\n Let\u2019s look at how your investment income is taxed (assuming no other income; in other words, you\u2019re living off your investments instead of a salary):<\/p>\n<\/div>\n Note that we\u2019re talking long-term capital gains; in other words, gains that are older than one year. If you buy an index fund today and sell it six months from now, that gain will be taxed like regular income. Not ideal.<\/p><\/div>\n Yep, you read that right: A single person can withdraw up to $48,350 per year from their investment account for the low, low price of 0% in taxes paid, if it\u2019s their only source of income. <\/p>\n $48,350!<\/p>\n And what if you want to withdraw, say, $300,000 per year? You\u2019re living high on the hog! You\u2019ve got six months to live! Time to finally pack your bags for Yacht Week and buy that Gucci tracksuit you\u2019ve been eyeing. <\/p>\n No problem. You\u2019ll only pay 15% in taxes on up to (I\u2019m throwing up) $533,400. <\/p>\n You know what EARNED income bracket gets charged 15%? The one between $40,000 and $80,000.<\/p>\n The government is basically incentivizing you to invest like a crazy person to the point that you can live off your investment dividends instead of a traditional job.<\/p>\n When you look at it from a tax perspective, it makes almost no sense to have a real job.<\/strong> In fact, it makes ALL the sense in the tax world to try to invest as aggressively as possible with your earned income so you can get to the point where you can live off your capital gains, which are taxed at a much, much more forgiving rate.<\/p>\n So now you can see why it\u2019s to your massive benefit to have enough in investments to not have to work (surprise!), but what about on the front-end? How could our friend have avoided such a high tax bill?<\/p>\n Pre-tax investment accounts. These are what we like to call tax shelters<\/strong>, because the federal government can\u2019t touch it until you go to use it later, strategically at a time where you\u2019re in a lower tax bracket. Checkmate.<\/p>\n What would\u2019ve happened if our friend had maxed out their 401(k) instead of taking home all their income?<\/p>\n At an annual maximum contribution of $23,500, our friend could\u2019ve lowered their taxable income like this:<\/p>\n Income<\/strong>: $125,000<\/p>\n 2025 standard deduction for a single person<\/strong>: Subtract $15,000 for the standard deduction, which lowers taxable income to $110,000<\/p>\n 401(K) maximum contribution<\/strong>: Subtract $23,500 for the 401(k) contribution, which would go into the 401(k) completely untaxed<\/p>\n New taxable income<\/strong>: $86,500<\/p>\n There are other tax-sheltered accounts this person could play with, like HSAs and IRAs, but for the sake of our example today, we\u2019ll keep it simple. <\/p>\n An HSA<\/strong>, or Health Savings Account, is an account that you\u2019re eligible for if you have a high-deductible health insurance plan \u2013 the contribution limit for a single person in 2025 is $4,300. When I found out I owed $5,000 in taxes this year because I underpaid throughout the year, I put the maximum contribution into an HSA to defer that income from taxation and ended up lowering my tax bill to $4,000. One step at a time! The cool thing about the HSA is that you can actually invest the money in it once it crosses the $1,000 mark (typically). <\/p>\n<\/li>\n An IRA<\/strong>, or Individual Retirement Account, comes in two flavors \u2013 Traditional and Roth \u2013 and I\u2019ve written about them extensively. A traditional IRA, which would\u2019ve been a great tax deferral vehicle, wouldn\u2019t work in this example because our friend with a six-figure income is over the income limit. #sad.<\/p>\n<\/li>\n<\/ul>\n Now? Our friend owes ~$23,500<\/strong> in federal taxes and FICA, roughly $6,000 less<\/strong>. <\/p>\n That\u2019s an annual savings of $6,000 by doing nothing more than putting your earned income into a tax-sheltered account. <\/em><\/p>\n Theoretically, if you had no other earned income, you could \u201cmake\u201d $96,700 as a married couple filing jointly in dividends and capital gains and live on it completely tax-free.<\/p>\n The trick? Invest aggressively enough, early<\/em> enough to build up a massive portfolio that\u2019s capable of throwing off $96,700 per year in capital gains. Easier said than done, but hopefully this serves as spite-motivation to stiff the Feds on the taxes you\u2019d otherwise be paying them if that $96,700 were earned income.<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":" If you can\u2019t beat \u2018em, evade taxes like \u2018em. Just kidding \u2013 there will be no tax evasion here (you hear that, little FBI man that resides in my MacBook Air? No need to call Jim at the IRS, because everything in this post has its origins in tax code loopholes, laws, and cultural differences between […]<\/p>\n","protected":false},"author":178814,"featured_media":2441,"comment_status":"closed","ping_status":"open","sticky":false,"template":"si-template-single-post-401-k-s-and-iras.php","format":"standard","meta":{"footnotes":""},"categories":[37,35],"tags":[47,57,44,64],"class_list":["post-166","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-independence","category-investing-and-taxes","tag-401ks-and-iras","tag-popular-401ks-and-iras","tag-taxable-investing","tag-popular-taxable-investing"],"yoast_head":"\nIsn\u2019t avoiding taxes illegal?<\/h4>\n
Why the wealthy hide most of their net worth in investments<\/h4>\n
\n
How would investing have helped this individual?<\/h4>\n
\n
![\"\"\/](\"https:\/\/moneywithkatie.com\/wp-content\/uploads\/2021\/03\/Screenshot2025-03-21at32616PM.webp\")
<\/p>\n\n![\"](\"https:\/\/moneywithkatie.com\/wp-content\/uploads\/2021\/03\/Screenshot2025-03-21at32845PM.webp\")
\nAnd that\u2019s why strategically wealthy people shovel all their money into investments that generate income that isn\u2019t (or barely is) taxed.<\/h4>\n
\n