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The financial independence, retire early (or FIRE) movement has come up with a lot of interesting strategies. But you don’t have to retire by 40 to make use of some of the ideas prevalent within the FIRE community.
Here are three valuable strategies straight out of the FIRE playbook that can bolster your retirement savings.
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1. Your HSA could be a super-charged retirement account
If your health insurance plan qualifies for a health savings account, or HSA, you have access to one of the most powerful retirement accounts available.
The HSA was designed to give people in high-deductible insurance plans a way to save money on their medical bills through tax incentives. Contributions to an HSA are tax-free, and if you use the funds to pay for a qualifying medical expense, you don’t pay any taxes on the withdrawal either.
But what FIRE adherents do is contribute to the account and invest the funds for retirement. Meanwhile, they pay for any medical expenses with other funds and keep the receipts. Once they’re ready to make withdrawals from their HSA, they submit the receipts for the amount they want to withdraw.
Tax-free contributions. Tax-free growth. Tax-free withdrawals.
The HSA has an additional tax advantage. Any contributions made directly from your payroll will be exempt from payroll taxes.
If you don’t have a lot of medical expenses, you can start taking withdrawals without any penalties at age 65. You will, however, have to pay income tax on withdrawals if they’re not for qualified expenses.
2. Pay 0% in taxes on your capital gains
You probably know long-term capital gains receive a favorable tax rate. Most investors will pay a 15% tax on the gains above their principal investment. But there’s actually a 0% tax bracket for capital gains, and the FIRE community takes full advantage of it.
The 0% tax bracket for capital gains applies to taxable income below $41,675 for single filers and $83,350 for couples filing jointly. As long as your total taxable income stays below those amounts, you won’t owe any federal capital gains tax.
Importantly, you don’t have to get rid of your investment to take advantage of the 0% capital gains tax bracket. You can sell your stocks (or whatever asset has capital gains) and immediately repurchase them. This will trigger a taxable event, but the tax will be 0%. The end result is a step up in the cost-basis of your investment, permanently locking in 0% taxes on your gains. The process is called tax-gain harvesting.
Tax-gain harvesting is best used in years with low income. For most people, that will be early in retirement, before you start collecting Social Security and you’re forced to take required minimum distributions from your IRA. While that period is longer for FIRE folks, anyone can utilize the process to minimize their tax burden.
3. Unlock the mega-backdoor Roth IRA
The Roth IRA is a great vehicle for high earners to save for retirement. But you may want to see if you can access the mega-backdoor Roth IRA, which could enable you to contribute tens of thousands of dollars more to your account every year.
The mega-backdoor Roth is accessed via your employer’s 401(k) plan. If it allows non-Roth after-tax contributions and in-service withdrawals, you’ll be able to unlock this strategy,
Here’s how it works.
There are actually two contribution limits for a 401(k). The first limit is the amount you can defer taxes on. That’s $20,500 for 2022 (or $27,000 if you’re 50 or older).
The second limit is the total amount that can be contributed to the plan in your name. That includes your tax-deferred contributions, your employer match, and any additional non-Roth after-tax contributions. That limit is $61,000 for 2022 (or $67,500 if you’re 50 or older).
So, if you max out your tax-deferred contributions, and your employer adds another $5,500 on top, total contributions would be $26,000. That leaves room for an additional $35,000 of after-tax contributions.
Once you add that $35,000 to your account, you can roll it over into a designated Roth account or withdraw it to a Roth IRA if your plan allows.
While you don’t have to max out the mega-backdoor Roth, you can use it to get more funds into your tax-advantaged accounts.
Get FIREd up
Using some of the same strategies as the FIRE community can help you save more for retirement and reduce your tax burden. Even if you plan to keep working until traditional retirement age, you shouldn’t ignore the clever ideas many people following the FIRE path have come up with. The above strategies can be part of any retirement plan, regardless of what age that retirement starts.
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