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May 9, 2019

Retirement Idiots

Uncle Sam doesn’t give out too many freebies when it comes to tax time, except in the form of retirement plans.

Surprisingly, not many people take advantage of them.

Only 41% of people contribute to a 401(k) when they have the option to do so. A 401(k) allows annual contributions up to $19,000. If you maxed out your contributions, you could save thousands of dollars on your taxes.

For the people who ran out of cash during the government shut down, that money would have come in handy.

Why do more people not contribute?

1. They say they don’t have the money. Wrong—everyone has the money. This is what saving is all about.

2. They don’t know about it. Sounds hard to believe, but I have met people who don’t know about the existence of these tax-advantaged retirement plans.

3. Laziness.

4. Taxes are too hard to figure out.

5. Etc.

That is a lot of money to leave on the table. You know what? If you make $100,000 a year, you can max it out. I guarantee you can do it. You can still have a cup of coffee once in a while!

At a 25% tax rate, you will save almost $5,000 a year in taxes. That is a lot of money to a lot of people. People don’t really view it as money, because many things feed into your income taxes. But let me tell you, if you contribute zero one year, and max it out the next, you will notice a big difference on your taxes.

Smart investors save as much on taxes where they can. Warren Buffett saves pretty much all of his taxes. He hardly has any tax liability at all. We can’t all be Warren Buffett, but the least we can do is take advantage of very obvious tax breaks where we can.

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The SEP IRA

The one retirement plan that goes completely overlooked is the SEP IRA. The SEP is for self-employed people, sole proprietors, single-member LLCs, etc. With a SEP IRA, you can shield a massive $56,000 a year from taxes. If your tax rate is 30%, that’s almost $17,000 in tax savings.

I have been taking advantage of the SEP IRA for years. 50-odd thousand goes into my retirement account every year. You don’t even need any growth in your retirement funds for this to add up quickly. If you do this over the course of your career, you’ll have over $2 million, with no investment gains. Not to mention the tax savings.

I run into a lot of self-employed folks who don’t even know of the existence of a SEP IRA. It is very common. If everyone who could contribute, did contribute, I wonder what it would “cost” the government in terms of lost revenue?

Those discussions haven’t started yet. They might someday. The government is spending a lot (an understatement) and currently nobody seems to care about debt. That might change, in which case the government will be looking for every bit of revenue they can find.

Retirement plans have been sacrosanct, but nothing is permanent. These plans might one day disappear. You can see how the narrative will run: “Who needs a $17,000 tax break? Only rich people.” And so on.

Tax Aggression

Some people are very aggressive on their taxes.

I am not. There’s not much I can do, anyway. Newsletter-writing is not a capital-intensive business and I have huge margins. Outside of travel and a couple of computers and a little market data, there’s not much to write off.

Having said that, I take every benefit I am entitled to. Let me put it this way: you wouldn’t not take your mortgage interest deduction because… you didn’t feel like it? Or it was hard? The bank makes it easy, they send you a 1099 with the interest you paid, and you or your accountant plug it in the computer. Retirement plans are really no different.

My guess is that the savings reflex for a lot of people is weak, which is a running theme in this newsletter. Maxing out a $19K 401(k) contribution seems distasteful, compared with the alternatives. To me, Alpo seems distasteful, compared with the alternatives. If the tax code encourages you to do something—whether it is buy a house, buy a Tesla, save for retirement, or something else—I suggest you do it.

Nobody is going audit you because you took every dollar of a SEP IRA contribution. There are a million ways to get audited, but that is not one of them.

Open up any popular finance website and you will get bombarded with propaganda telling you to save for retirement. The participation rate is nowhere near 100%, for basically the same reason that people don’t refinance their mortgages when interest rates go down. Lots of people moan about Wall Street taking advantage of Main Street all the time.

Well, that’s because you make it easy.

Jared Dillian
Editor, The 10th Man

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