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The Power of the IRA and 401k for Aspiring Digital Nomads

Updated: May 31, 2018

If you're still stuck in corporate America saving money to launch your dream of becoming a digital nomad then you may not be thinking of the retirement plans available to you. You're most likely putting all that money in a savings account and earning 1.5% (on the high end) a year. While this may be a good strategy if you're planning to use that money in the short term, there are a few problems if you take a look at the bigger picture.

The Tax Advantages of the IRA and 401k

If you're goal is to save as much money as possible for the future, you are going to want to utilize the IRA and 401k. Why? Because you can save a lot of money in taxes. Less money paid to the government is more money for you to put towards your future dream. How much savings are we talking about it? That depends on which income bracket you are in (see the table below). However, let's assume that you're in the bracket that includes people who have a taxable income between $38,701 and $82,500 which is taxed at 22%. If you contribute $5500 (the annual maximum contribution) to a Traditional IRA, that income is now deferred from taxes and you would pay $1,210 (22% of $5500) less in taxes that year. This strategy can be extended to the 401k as well which allows a contribution of up to $18,500 per year (another $4,070 of savings per year if still in the 22% bracket).

2018 US Tax Brackets
2018 US Tax Brackets

At this point you may be thinking that you can't access that money until you're old and retired and that you'll have to pay taxes on it down the road anyway. However, that isn't entirely true. With proper planning, you can access the funds in your IRA or 401k much earlier and pay zero to minimal taxes. How do you do this? Well the MadFientist has already explained this strategy in great detail in his article entitled "How to Access Retirement Funds Early." In his article, he goes over the Roth Conversion Ladder which entails slowly converting your Traditional IRA or 401k into a Roth IRA. The conversion requires you to pay taxes on the amount converted, however if done slowly, you can convert small amounts to stay in the lower tax brackets. In 2018, the standard deduction is $12,000 for individuals. Therefore, if you convert $12,000 you would pay ZERO taxes on that money. The final catch? You have to wait 5 years before withdrawing that $12,000. This strategy may not be right for the impatient, but for those who are willing to plan and wait, the savings can be immense.

An Additional Benefit For Digital Nomads

This strategy works even better for digital nomads who are living and earning money abroad because they can take advantage of the "Foreign Earned Income Exclusion (FEIE)". The FEIE allows you to pay zero taxes on income up to $104,100 if earned outside the United States. Therefore, you can earn up to $104,100 and convert your $12,000 per year for the Roth conversion and pay ZERO taxes on all of it!

For more information on the Foreign Earned Income Exclusion, see the below references from the IRS:

Foreign Earned Income Tax

Finding a Balance

Now, not everyone can afford to wait 5 years or more to access their money, but for those that can, this strategy can save thousands per year in taxes. However, I believe most can find a balance. You're going to need some money to get you through those first few years of being a digital nomad, so keep saving some of your income at your corporate job in that savings account. While you're doing that, consider putting some money aside into an IRA or 401k to reap these tax savings.

Disclaimer: This article is for informational purposes only and is not intended to be tax advice. You should consult a tax professional to determine what is best for your situation.

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