What is Financial Hack Stacking? And How Do I Use it to Build Wealth?
Mail Call
This post is brought to you thanks to reader Kostas with the following comment:
…Can you please expand or share some resources on the “financial hack stacking” Mr. Refined…? Thanks
Kostas, there is nothing more
Still here? OK, that means to are no longer a Padawan Apprentice, you are ready to level up and become a Jedi Knight. I consider this Level II FI Hacking, it is not for the uninitiated. Not that beginners couldn’t do it. It just is not the most effective use of their time when they are leaving bigger money on the wrong side of the ledger.
What is Financial Hack Stacking?
Financial Hack Stacking – is an advance financial independence strategy to use multiple dynamic variables to compound the results of your effort. Multiple individual financial hacks (financial short cuts) compound together to be synergistically more effective than the independent constituent components.
In other words, you effectively save or produce more wealth by combining individual strategies together. This is a financial force multiplier. If you are looking to cut years off of your FIRE walk (or time until retirement, if you are a traditional retiree.) This article will turbo-charge your journey.
The Stack – Most Basic Example: Theorem Time
You get C because you have B. You get B because you did A.
A is worth $2
B is worth $2
C is worth $2
Independently, A+B+C add a value of $2+$2+$2 = $6.00
You with me so far? Here we go…
The Force Multiplier:
ABC used together is AxBxC which add a value of $2x$2x$2 = $8.00
And by the way $8 > $6. This is where all the cavemen grunt…”UG MONEY GOOD.”
See, by combining or stack the hacks together and you get a more effective result.
Let’s look at two real-world examples from my life on how this works.
Financial Hack Stack Example 1: Funding My Retirement Tax-Free
No, I didn’t mistype that, I meant tax-free not tax differed. If you think that sounds too good to be true, check this out.
Phase 1: Pre-59½
Let’s assume that I don’t want to save up enough money to have a “perpetual money machine.” whereby my account grows faster than I spend, like most traditional retirees. Let’s also imagine that I survive to the age of 45 somehow (that would be a miracle with my luck) and I retire then. I could draw out of my Roth account to cover living expenses. A Roth account is designed such that you get to withdraw tax-free and penalty-free at retirement. The idea is that you are supposed to pay tax on income on the way in the account when you fund the account.
Since I will be 45, I will not be the ‘normal’ retirement withdrawal age of 59½ years old. Thus, I can only withdraw principle (dollars that I contributed) tax and penalty free until the age of 59½. The growth on that principle stays in the account at this point. Then once I cross over the 59½ mark I could withdraw from either the principle or the growth (from appreciation and dividends) tax and penalty free. So I would have the contribution portion for my early retirement age of 45 until I reach the government’s idea of ‘normal’ retirement age of 59½.
Note: there is a five-year minimum vesting period with a Roth account. Thus, you must leave your money in for at least five years to be able to withdraw your contribution principal penalty free.
Phase 2: Post-59½
Assuming I am still alive, from the age of 59½ until I die, I could live on the growth portion of the account. Of course, I won’t have to actually do that since I will follow the 4% rule so I have strong odds of that money lasting for perpetuity. In other words, my account will be funded enough and I will draw down a small enough percent (<4%) that the money will grow faster than I spend it and it will last well beyond my lifetime.
So I get to withdraw tax-free because I used a Roth account. I also get to withdraw penalty free in early retirement by taking a contribution from the right category (contributions only, before age 59½, then growth.) Who really cares, money is money.
“But
– Kostas might contestwait Mr. Refined you still have to pay taxes on the income on the way into the Roth account to fund it.”
Tax-Free Wealth
Well, I would, if I had to pay income taxes. But I have a solution for that too. Would you expect less from me?
I reduced my tax liability (how much income tax I have to pay) with a combination of deductions like, single head of household, homeowner, mortgage interest, tithe, medical, schedule C for a small business losses, stock losses (even if you have a net gain you can write off the losers. [Now if only dating were that easy]) etc. By the way, where you buy the “risky stocks” is very important but that is an article for another time.
Then I reduce my tax liability even further by maxing out contributions to tax-advantaged account such as DCFSA, HSA, IRA, 401k, etc.
It fluctuates a little every year but I get down to the 9% bracket or below. Then I use tax credits offset the remaining tax liability of nine or less percent. I use credits such as two kids, adoption credit, etc.
Your specific situations will vary. Your reductions and credit will be specific for your situation but don’t worry there are 73,954 pages (according to Business Insider) of them in the IRS tax code for you to utilize. Trust me, it is hard to run out.
So now we paid no income tax and we have a nice little credit left over from Uncle Sam that we can use to help fund the IRA account.
The Stack
- No tax on the way out (because it is a Roth)
- No tax on the growth (because it is a tax-sheltered account)
- No tax on the way in (because I don’t carry an income tax liability)
- Funded in part because save a large portion of my income and I can save a large portion of my income because I don’t have to pay income tax, how harmonious the right side of the ledger is.
According to USA Today “The average American’s effective 29.8% of their lifetime wealth to income tax” if you remember that statistic from the article two weeks ago.
How to Move Your Retirement Date Up 30 Years
Imagine if you have 29.8% more to invest. What would that do for your retirement? Ok, enough imagining we have math. Let’s compare Sexy Smart Sara to Regular Rob. Both make exactly the median American household income of $61,372 by coincidence.
Regular Rob saves 10% of his income and his advisor says he is doing just fine. As you can see from the chart below he with be able to retire in a short 51.4 year working career…yuck.
Now let’s check in with Sexy Smart Sara who saves 10% of her income plus the 29.8% that she chose not to donate to government This adds up to 39.8% of her income. and please allow me to round to 40% for easy-to-follow math. This represents a ‘normal’ savings rate plus the income tax savings. We assume that the difference all goes to savings. As you can see from the chart below she will be able to retire in a short 21.6-year career…I bet she is still sexy then…and rich too. Now please excuse me. I will give you I minute to ponder that while I go hit on Sexy Smart Sara.
So what if you love your job so much you don’t want to retire early? Fear not, I can math that out too.
Let’s assume Regular Rob and Sexy Smart Sara both work a traditional 40-year career. Remember they make the same income. Now the only difference is the savings rate. Let’s see if the saving rate alone can have an impact on your net wealth. (I say net wealth because no amount of wealth determines your worth.)
How to Move Up to a New Wealth Class
See how the rich get richer while everyone else pays their taxes. I never said it was fair but now that you know how to identify the winning play you can join the winning team. Tax is one of the three tools used to transfer the wealth from the uninformed to the silk-lined pockets of the informed. The best part is that if you chose to inform yourself, you can be the one that benefits from the laws already at play. These laws are carefully crafted to benefit the informed class. Traditionally, this has been the wealthy class until the internet and a few bold bloggers decided to turn that paradigm on its head and reveal these fun financial hacks to their own kin. That would be you.
“The Future belongs to the learners, not the knowers.”
– Eric Hoffer via @RefinedByFIREco
- Notice that this FI hack was funded in part because of an adoption credit from adopting a foster daughter.
- I adopted a foster daughter because I am too frugal to pay for a traditional adoption.
- I foster because I am too frugal to pay for a hospital birth bill (and I can’t afford a wife unit.)
- I am too frugal to pay a hospital bill because I want to fully fund my HSA account
- I want to fully fund my HSA to zero my tax liability.
- I zero my tax liability so I can save a fat stash of cash in my investments.
- I need a fat stash of investments to be able to afford a wife unit one day. Ahh, another circle of serendipity.
Financial Hack Stack Example 2: The $15 Internet Bill
I used to pay $65 per month for internet or $780 annually. But I refined that a bit. Now I pay $15 per month for internet or $180 annually. That is an annual savings of $600. But that is just the tip of the iceberg. There is much more to this below the surface. Let’s have a look.
I qualify for discounted internet of only $15 per month because I have someone in my household that is on national reduced school lunch plan. I have someone in my house on a national reduced lunch plan because she is on Medicaid and that is one of the qualifying criteria for the reduced lunch plans. She is on medicate because she is my foster daughter so technically the state owns her and thus pays for the medical costs.
The FI Hack Stack is a
If you tell me “I can’t do FIRE because of kids.” I will tell you “I will FIRE because of kids.” Don’t say I can’t do that or I can’t afford that. Rather ask “How can I do or afford that.” Reframing the question rewrites the matrix code. You make your own reality in the game of life, one decision at a time. Construct your reality well.
That is how you FI Hack Stack!
Keep the FIRE burning my friends.
Disclaimer: This site is for informational and entertainment purposes only and shall not be construed as investment or tax recommendations or advice. Because of the nature of the interactive dialogue inherent in the format of this site, it is important for readers to understand that not all comments made will apply to them specifically. Nothing said shall be taken to be investment or tax advice, nor shall statements on this site be considered an offer to buy or sell securities. Such advice is rendered solely on an individual basis and at times will require that the investor review a prospectus. You should seek advice for your specific situation from a certificated financial advisor and a certificated tax advisor. Most days, I don’t claim to be an expert or even an adult.
