Financial Mistake #6: Not Utilizing Tax Efficiencies With A Reduced Income

Financial Mistake #6 – not utilizing tax efficiencies when unemployed and in a low tax bracket. 

This is a tough one for me.  Many a night did I contemplate if I should include this in my financial mistakes segment, and after serious reflection, I have concluded that, yes, I should.  Although hindsight is 20/20, I should have found the courage to act when fearful.  But I didn’t.  And instead, you get this post that will hopefully give you some ammo to unload if you happen to find yourself in a similar unfortunate situation staring down the crosshairs. 

Unusual circumstances lead to rare opportunities. 

For most people, they will work their entire lives and never have a point in which they are involuntarily unemployed for a long stretch of time (I’m talking normal circumstances, not sickness and disability).  Sure, people are laid off, but these job losses, at least in my experience, only last for several months.  Let’s say 6 months at the most.  But one entire year?  No, no, no.  That only happens to people who have something wrong with them.  You must not be looking hard enough for a job, you must not be networking enough, or you must be doing everything wrong. 

But in 2017, that’s the position I found myself in.  I was left scratching my head in a situation that most people said was impossible to be in if I had minimum employable skills.  Yet, there I was.  I’m not going to get into details in this post, but it was a beyond challenging year to say the least.  I’ve already written about my job loss here and I’ll be detailing the psychological effects and emotional struggles that one year of unemployment had on me in a future article. 

Because when you start getting into unemployment for that long (non-virus related), it shakes you down to your core.  You begin to question everything, your confidence, your skills, your motivation, your drive.  With every additional month, you lose a little more self-worth and the self-doubt and insecurity start seeping into your thoughts and dreams like water into sand.  Every time you talk to friends or family, and of course they ask you for an update, you wear the shame of your predicament like a scarlet letter branding you as unworthy.  Because unfortunately, we are defined by our work in the US.  Our identify and status are dependent on career success.  Strip that away and you’re left with a frightened and doubtful creature lost in a jumble of human emotions that can’t tell up from down any longer. 

However, as devastating emotionally this can be to one’s ego, the circumstances themselves presented a financial opportunity.  With a lower income, came the possibility of increased advantages for tax efficiency.  Who would have thought?  Making less money has its own perks. 

When forced into a lower income bracket, take the time to understand what new benefits and options might be at your disposal. 

My year of unemployment was more of an emotional struggle than an actual financial one.  But don’t get me wrong, it hurt losing an entire year of my breadwinner salary.  Let’s make no mistake about it, that was brutal.  Yet at the same time, I was always a saver and invested prudently for a situation just like this one (now, I never envisioned it would actually happen to me, but I was prepared nonetheless).  My wife makes the median US salary and we were able to pretty much almost breakeven on her income alone while we still saved in her 401K.  As you know, we are not big spenders, so we survived and never had to dip into real savings (I consider “real savings” invested capital that I should never have to pull out unless making an investment decision.  Cash on hand, is well, that… cash… haha). 

However, it’s still a little embarrassing writing this that we couldn’t break even 3 years ago (we are way more efficient today since I actually started tracking our spending in 2018).  Regardless, my point is, I lost 70% of my income but still made it through the year on a reduced budget and came out okay.  Yes, I was humbled beyond recognition, but life was palatable.  I don’t think the average US household would have been in the same situation, but I digress. 

So, what was my mistake? 

My mistake was, with this reduced income, there were certain tax moves I could have made in order to take advantage of our significantly lower tax bracket.  The particular opportunities, in my eyes, were either realizing capital gains at a decreased rate or making an IRA conversion to a Roth IRA again at a lesser rate. 

Since we file taxes married filing jointly and based on the reduced income especially with both of our minimum deductions, we had a good chunk of change that we would have been able to convert almost tax free – we’d still have to pay the CA income tax on it of course.  Good ol’ California always needs to claim their piece of the pie.  Nonetheless, this would have been an overall win during a very down year for me. 

So, why didn’t I do this?  What insurmountable barrier stood in our hero’s way?  Nothing… only myself.  

Fear got the best of me. 

When we don’t want to face the music and take responsibility for our lives, it’s easy to make excuses.  Well, this thing was going on, and I was so stressed and busy with this that it’s understandable I didn’t act.  But when it comes down to it, we choose to wear a cloak of lies, no one forces us to put it on. 

I knew our joint income was lower at the end of the year.  I should have called my accountant and asked how I could be proactive in this situation and what his recommendations were.  But I didn’t.  I let the fear creep in and started worrying about what happens if this job loss continued even longer… maybe an even unthinkable additional year?  And then the negative spiral of self-doubt had me in its grip like a vice. 

I simply didn’t act.  And by doing that, I chose the action of defeat.  I just ignored it and justified to myself, I’m too stressed, this just isn’t a good time to do this.  Then I became unsure and second guessed myself. 

Looking back, I missed a big, ripe opportunity for the taking.  Sure, when I reach FI I’ll be able to do Roth IRA conversions if my income is low enough, but in the long run, this mistake isn’t really going to matter.  Yet at the time, if I was a little wiser and had more confidence, I could have saved myself some tax-free returns into perpetuity.  How much did this mistake cost me?  I don’t want to know. 

This is a sunk cost that I’m going to sweep under my pillow, and after writing this post, never worry about again. 

But I will offer some rare advice on this blog (or is it?  Isn’t writing a post itself advice?  Yes, a question to ponder for another day).  If calamity strikes and your income is severely reduced, before the year is over, investigate all your options for tax/investment optimization (even though this will probably be the last thing on your mind).  Because more likely than not, there’s probably something you can do with your investments to get a small patch of blue sky in the storm of your misfortune. 

Be safe out there my comrades and I hope everyone had a great 4^th of July. 

-Q-FI 

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P.S.  Have you ever taken advantage of tax efficiencies when having a lower income?  Or found yourself in a similar situation of failing to act?  Let me know.