Tax Resister Tom Cooley’s Technique

Tom Cooley writes in about his experience with tax resistance:

I’m not an expert on these matters, but I’ll try to unravel some of these acronyms. A 401k is a tax-deferred retirement plan where your employer deducts some money from your paycheck (and may add in a little extra money) which is then held in an investment account set up by the employer (or, more likely, by some company that specializes in such things that your employer hires for this purpose). You have some limited control over where the money that you’ve put in this plan is invested (usually you can select from a handful of funds). You are not taxed on any of this money as it is being put into the plan, but you will be taxed after retirement when you start withdrawing the money (if you try to withdraw before retirement, you pay taxes and penalties). Typically you can put up to 15% of your income into a 401k.

An IRA is also a tax-deferred retirement plan (however there are also forms of IRA in which the tax is paid up-front, rather than at withdrawal time). You put the money into the account yourself, rather than having your employer do it by deducting money from your paycheck. Because you set up the account yourself, you have a lot more control over your investment options. You’re allowed to put $3,000 per year into a tax-deferred IRA (this number can change from year to year as the tax law changes).

An “SEP” is like a 401k plan in that your employer puts (typically up to 15%) of your paycheck in to this plan. However it’s more like an IRA in that you set up the account and have more control over the investment options.

The “new retirement savers contribution credit” is this “miracle form 8880 that I mention in the FAQ. In short, it gives you a tax credit if you’ve got a low income and still manage to put money into retirement accounts like the ones discussed above. The credit is meant as an incentive for poor people to save up for when they’re old and the Social Security system goes belly-up. The credit is at its maximum for people with an “adjusted gross income” below $15,000. If you can get your adjusted gross income down to that point, and you’ve put at least fifteen hundred dollars or so into one of these retirement accounts, you’re almost certainly 100% in the clear tax-wise. And your “adjusted gross income” is calculated after you’ve already deducted your contributions to tax-deferred retirement accounts from your income, so you get a double bonus.

Here’s an example: Alice, Brian, Celia and Don are unmarried people with no dependents. Alice and Brian each have a salary of $21,000 per year; Celia and Don each make $15,000. Alice puts away the maximum 401k contribution of 15% and also puts $3,000 into a tax-deferred IRA; Brian and Celia do neither; Don puts 8% of his paycheck into a 401k. Here’s how this works out for them:

AliceBrianCeliaDon
Income21,00021,00015,00015,000

401k contribution3,150001,200
IRA contribution3,000000
Federal Income Tax01,6307300

Total saved for retirement6,150001,200
Total available to spend this year14,85019,37014,27013,800

Total amount of salary kept21,00019,37014,27015,000

Note: This is over-simplified. It leaves out state taxes, social security and medicare contributions, and the effects of other deductions that people can claim.

There’s still the question of how your money gets taxed when you finally get around to withdrawing it at retirement time. I believe it gets taxed at whatever rate you’re paying then — so if you’ve planned well and are still comfortable living below the tax line then, you can withdraw funds at a slow enough trickle so that you will continue not paying taxes on them. I’m not sure if that’s the way the law works, though, so correct me if I’m wrong. And in any case, the law is subject to change and so it’s hard to predict how vulnerable these retirement funds are to future taxation.

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