Taking Advantage of a Low Income Year

I first heard the term “mini-retirement” when reading The 4-Hour Workweek by Tim Ferriss several years ago, and it really clicked with me as someone who was just starting their career. In short, as an alternative to working ~40 years straight before starting out to live your life on your own terms, you slide in a few “mini-retirements” every few years to break up and take advantage of your “retirement” years at an earlier time. In theory, you are likely more energetic and physically better able to travel and pursue other passions than you would toward the later years of your life. These mini-retirements could also be used if you are feeling stale in your career to take some time off to reassess your career goals and to pivot toward a different direction if necessary.

I bring this up because I am currently on a mini-retirement and using the time off to build a company that has been formulating in my mind for a few years. I had planned on taking a year off from a traditional office job once I was able to pay off my rental property and use the cash flow and some side-hustles to fund a non-working period, using my newfound time to build a business. There were also a few things I planned to take advantage of with my lower income, due to how the progressive tax system that is employed by the United States and the common wisdom that necessity is the mother of invention.

With the lowering of income in the economy due to COVID-19, many people will have a lower income than they may have planned for 2020. While there are many obvious stressors that come with this lowering of income in the short-term, there are also long-term benefits that can be had if the right actions are taken. I want to share my financial goals for my mini-retirement year in the hopes that anyone finding themselves with less income can still take some action that will benefit them long-term.

A) Converting IRA funds to Roth IRA

While most people wait until retirement to pay taxes on IRA distributions, you can pay taxes on these distributions earlier and in a more controlled manner to lower your tax burden from these distributions. If you know that your income is going to be low for this year, you can convert funds in a traditional IRA over to a Roth IRA right now. Any amount you convert will be treated as income, but you will be guaranteeing a low tax rate on that income. After that, your money can grow and be taken out tax-free for the duration of its time in Roth IRA, and you won’t have to worry about getting hit with higher taxes on that money down the road if your income is higher and/or you have to take a large Required Minimum Distribution.

B) Locking in Capital Gains

Using similar logic to item A, you can use a low income year to pay very little tax (in many cases, no tax at all) by forcing recognized capital gains. For most people, these gains will come from stocks in taxable brokerage accounts and other personal property and rental real estate sold at a gain. Due to the favorable tax treatment given to capital gains, if you have capital gains that make up a yearly adjusted gross income where the highest marginal tax rate you have to pay is 12%, you would pay NO federal taxes on those gains. We will use a case study in the coming weeks to illustrate this benefit that you can potentially apply to your tax situation.

C) Truly Consider Wants & Needs

Backing off a bit from the technical advantages, a low income year allows us to more honestly evaluate the things we want in our life compared to the things we absolutely need. I say that it lets us evaluate these two categories more honestly because when times are good and we’ve had financial success, we can start to get used to certain things being a part of our lives so much that they begin to feel like a “need”. However, when things go downhill a bit and we need to tighten the purse strings, we can challenge ourselves to take inventory of what’s really important to us and see if we can survive (and still be happy) without things we may think we “needed” before. While this may take some getting used to, any excess we can cut out of our lives will remove the stress that comes with paying for that excess when our money is more limited.

D) Finding More Bang For Your Buck

This relates to getting more value for a similar price paid, or the same value for a lower price paid. Amanda and I constantly look to do this in all areas of our budget, and if you haven’t gotten in the habit of looking for better value everywhere, then this is a great time to start. My most recent value-add was switching cell phone providers from Sprint to Mint Mobile, paying what comes out to $21 a month with Mint Mobile as compared to $46 with Sprint. While I have a limit with Mint Mobile for the amount of data I can use per month (8GB), I was able to turn off data for all apps that used to suck up the majority of my data (ESPN was a huge culprit), and now I don’t come close to hitting the limit. This made the switch much easier and I don’t notice a difference at all.

Other big value-adds that we employ include getting most of our food from Aldi and Sam’s Club instead of Publix, random one-off buys (especially medicine) from Dollar Tree instead of many other more expensive stores, and airline flights booked almost exclusively with points (bad example at the current time but we are hoping this will be a big value-add again soon!)

E) Finding Free & Inexpensive Things that Make you Happy

Amanda and I took a bike ride around an old fishing village called John’s Pass near our house the other day. It’s a place that is normally buzzing with tourists going in and out of the many bars, restaurants, tacky tourist shops and ice creams stands, but everything there was closed on the day we went. Even still, I had such a great time finding shops I’d never heard of before, the weather was gorgeous, and we just happened to get exercise. I noticed how much I enjoyed that particular day and how it did not involve spending any extra money whatsoever. I look to repeat days like that and challenge you to do the same, especially if your savings runway is a bit short.

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