March 22nd, 2024  [4 min. read]

By Drew W. Boyer, CFP®

At first glance, you might be thinking of social security where private employees are required to pay into it through employment taxes. Public employees have a similar tax in the form of pensions from their salaries. If you’re working, you’re paying into one or the other.

But this isn’t a required federal tax or state pension- this is a self-tax.

Like the generic financial advisor advice of pay yourself first, I have a set percentage of self-tax on before my normal savings. That’s right, I purposefully tax myself 25% on certain income and set it aside in a completely separate account.  The IRS can’t touch it (yet) because It’s pre-tax money, so it lowers my income and grows tax deferred.

It’s not a 401k or an IRA. The official name they give it is ‘IRC Section 457(a) accounts.’ 

Layman's terms, please!  It’s called ‘Deferred Comp’.  A lot of my public first responder clients have ‘deferred comp’, but mine is specifically for private sector employees.  

Lost you yet?   Keep reading or just call a CFP® like me.

Of course, like all tax deals, it comes with strings.  

1. You have to be ‘eligible’. This is based off an earnings definition. 
2. I must pick a ‘pre-set percentage’ once a year that cannot be changed. 
3. There has to be a ‘substantial risk of forfeiture.’  As in, if the company goes under, my deferred comp account can be taken by creditors. 
4. There must be a ‘preset distribution’ selected. For me, it all has to come out between my ages 55-65 when I’m planning to work less, but not yet retired.
5. When it comes out, it’s all considered ‘taxable income’.

Not everyone can have one of these accounts, but it’s an idea of what executive types are playing around with to lower their income and defer taxes when they earn less in the future.

Here’s how you can make you own self-tax account, but without all the rules and most strings: 

Open a Non-Retirement Account. You can set up your very own self-security account today. Think of a Robinhood or Schwab account. As a non-retirement account, it has no contribution or age limits, is liquid, but carries certain risks.

Tax Risks: If normal retirement accounts like 401k’s and IRA’s have tax-deferred growth and ROTH IRA’s and ROTH 401k’s are tax-free, then non-retirement accounts are taxed anytime you have capital gain or income. That’s a key point to remember.

The way around taxes?  There aren’t.  

However, you can plan ahead and hold investments that are ‘tax-sensitive’ such as municipal bonds that pay tax-free interest and growth stocks that do not pay dividends (taxed as income).

Get the idea? We’re intentionally trying to pay as little taxes as possible.    

Then there’s the added magic trick-tax benefit of ‘tax-loss harvesting.’ Let’s jump in and explain.

Tax-loss harvesting is when your investment loses money, and you intentionally sell it.  However, you buy another investment to stay invested. It cannot be the same position unless 30 days have passed due to ‘wash rules’.  

Think back to the 2021 stock-meme days of ‘buy high and sell higher’. It was never buy high and sell lower- it’s counter intuitive.  So why would you? To deduct the losses. The IRS will let you deduct up to $3,000 per year, in capital losses, in perpetuity, until you have no more loss to deduct.  

Layman's terms, please! You get to make your own tax deduction, possibly for years, and it’s all above board.

For all you day traders and crypto-diamond hands out there, make sure you hold an investment for 366 days (367 days this leap year).  Holding an investment for one year and a day makes your potential investment gain a long-term capital gain which is taxed more favorably.  All short-term capital gains, held less than one year, are taxed as ‘income’ which is usually at a higher tax rate.

Investment Risk: I know the average attention span is 10 seconds nowadays, but remember the 2022 ‘Bear Market’ where stocks got crushed? You can always lose your initial investment. How’s your Dogecoin doing? Future performance is not guaranteed. Read the rest of the legalese below every investment prospectus.

If this is all Greek to you, perhaps you can call a CFP® to help you out?  Get in the habit of taxing yourself first and paying it forward through saving and investing. If you’re not eligible for a 457(a) deferred compensation account or don’t want all the strings attached, then consider a non-retirement account. You won’t be sorry.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. Boyer Financial Group and LPL Financial do not provide tax advice or services.