My Journey to Financial Independence and Retiring Early

How I Save Almost 40% of My Income Before I Even Get Paid

How to minimize taxes to save more - www.thefiredrill.comThe day I was hired full time at my company I inquired about setting up 401k contributions, which I wasn’t eligible for as an intern. Once I secured my role as a Research Associate in 2013, I started contributing 3% of every paycheck to the account. As I got further and further into the realm of financial independence, I realized I could contribute more and kept increasing my contribution percentage as I felt I could. Every raise went straight into the account. In 2015, I was able to contribute the maximum amount ($18,000) to my 401k and pay less taxes than I was before I received my raises. I am on track to max it out again this year.

In addition to the 401k, I also contribute the max to an HSA account. This account is available to those who are on a high deductible health plan (more on that in a later post) and is to be used for health expenses. However, the MadFientist has an excellent article highlighting how the HSA can be used as the ultimate retirement account. He explains it better, but the gist of it is you pay for any health expenses out of pocket and let your savings in the HSA grow until you need to pull the money out during your retirement years. Once you turn 65, the HSA can be used like a Traditional IRA where you just pay income taxes on withdrawals. The current annual limit for a single plan individual is $3,400 and $6,750 for families.

So before the direct deposit even hits my bank account almost 40% of my income is already saved!

Why do I prefer saving in tax-deferred accounts?

What most people don’t realize is their biggest yearly expense is actually taxes. What better way to increase your savings rate than by avoiding some taxes all together? Avoiding taxes gives you more money to invest now to let compound interest do its thing. It also doesn’t affect your paycheck as much as you would think.

Let’s look at an example bi-weekly paycheck for a single person with an annual salary of $60,000.

  • Base pay: $2,307.69
  • Social Security (6.2%): -$139.70
  • Medicare (1.45%): -$32.67
  • Federal taxes: -$338.35
  • State Taxes (MI=4.25%): -$89.22
  • Health Insurance: -$54.45
  • Take Home Pay: $1,653.29

Now let’s look at a paycheck for someone who is maxing out their 401k account.

  • Base pay: $2,307.69
  • Social Security (6.2%): -$139.70
  • Medicare (1.45%): -$32.67
  • Federal Taxes: -$165.27
  • State Taxes (MI=4.25%): -$59.80
  • Health Insurance: -$54.45
  • 401k Contributions: $692.31
  • Take Home: $1,163.48

 That’s only about a $500 difference in take home pay, but almost $700 in 401k contributions.

Now let’s max out our 401k AND HSA! HSA contributions also avoid FICA taxes (Social Security and Medicare), so those numbers are a little lower here.

  • Base Pay: $2,307.69
  • Social Security (6.2%): -$131.59
  • Medicare (1.45%): -$30.78
  • Federal Taxes: -$159.95
  • State Taxes (MI=4.25%): -$54.24
  • Health Insurance: -$54.45
  • 401k Contributions: $692.31
  • HSA Contributions: $130.77
  • Take Home Pay: $1,053.60

That’s a $113.96 difference in take home pay from the person maxing out their 401k, and an additional $130.77 in savings. Compared to the person with no pre-tax savings, the person maxing out both accounts sees $599.69 less per paycheck, but is saving $823.08 every 2 weeks! That’s $21,400 in savings a year while avoiding giving Uncle Sam almost $6,000 of your hard earned money! That’s more than a whole year’s IRA contribution! And this doesn’t even include any company matching that your employer may provide.

For 2015, my company gave a discretionary match of 10% of contributions of up to 3% of salary. Because I maxed out my account, I was able to get the full match adding about an additional $1,600 to the pot. Hello, free money! Many companies offer more generous matches than that, but this was a happy surprise for me. They also provide an annual $400 HSA contribution for single individuals, $600 for couples, and $800 for families.

Download our 2017 Paycheck Calculator below so you can input your specific numbers to see how much you can afford to stash away in tax deferred accounts.


Things I left out:

  • If you’re 55 or older, you can contribute and additional $6,000 to your 401k and an additional $1,000 to your HSA as catch-up contributions.
  • Traditional IRA contributions can also be made pre-tax, but not through your employer. I will cover IRAs in a later post.

How much do you put away in your tax-deferred accounts? Does this motivate you to increase your contributions?

How I Save 40% of My Income + Free Calculator

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