The joy of doing your own taxes is that you know where every single dollar of income goes. When our tax bill is not being optimized, we call this ?leakage.? I finished up my taxes with H&R Block?and realized I paid more in taxes than the total amount I spent to enjoy life. Holy Friedman Batman! Something is seriously wrong when the government is allowed to spend more of your money than you can spend on yourself. Or maybe I?m just not spending enough at all?
I?ve never thought about this ridiculous fact until I started comparing notes with a fellow tax hating friend. Everything can be explained by simple math. Given I saved around 70% of my net income after taxes last year, I have 30% in net disposable income to spend. If I pay more than a 30% effective tax rate (Federal+State+Medicaire+3.8% Medicare Investment Tax+Social Security), it ends up that I?ve paid more to the government than I?ve spent on myself!
The other way to look at these percentages is to take the effective tax rate (your total tax bill dividend by your non adjusted income) and divide by your savings rate after taxes (net savings). If you can save as much as your effective tax rate, then you are on the right track because it means you are at least keeping as much of your money as the government is taking.
This post will focus on your TITTS: your Total Income Taxes paid (effective tax rate) divided by your Total Savings after tax. The size of your TITTS will determine whether you are winning or getting bent over by the government. But first, a little philosophy about taxes.
MATH, TAXES, AND THE WAY OF THE WORLD
Fortunately for the government, and unfortunately for me, the majority of my 2012 income is straight W2 income. If all my income was in dividends or long term capital gains, my effective tax rate would only be around 15%. However, it takes a lot of time to be able to generate a portfolio where you will be able to live a comfortable, non-trailer park life in the boonies on just dividend income.
Based on various tax organization websites I?ve seen, interest income, dividend income, and pension income account for roughly 5%, 10%, and 12% of total income for those in the highest income brackets. Clearly, these percentages change with each individual, but it?s just good to understand the composition of incomes in various tax brackets. If you were to ask Warren Buffett his composition of income, 95%+ comes from lower taxed dividend income.
We should be fortunate to pay taxes. If we do, it means we have income. Furthermore, the more taxes we pay, the more income we have. A lot of people whine and complain about the 47%+ of Americans who pay no Federal income taxes, but they are missing an important fact. Sure, there are tax evaders, but the large reason why they don?t pay tax is because they have much lower incomes or are retired!
I?ve suggested each working American pay at least $1,000 in Federal Taxes a year to raise $120 billion in annual tax revenue for our budget. I think this is quite reasonable, as the total tax bill amounts to only $83/month. If you think it?s cruel to pay so much in taxes if you don?t pay in the first place, how about just $42 a month to collectively raise $60 billion to save our country?s finances? Either way, it?s important to broaden tax collection so that every American can have skin in the game to make our country great. Maybe not.
Before I retired, there was no way for me to significantly lower my tax bill. I?ve played with numbers, asked tax consultants, and did a ton of reading. As a result, I decided to break free and earn no W2 income. Paying more than a million dollars in income taxes by 35 should be more than my fair share. Now it?s time to enjoy a little more of the public parks, libraries, and everything our nation has to offer while I live off passive income and write.
THE IDEAL TOTAL INCOME TAX TO TOTAL SAVINGS RATIO
The TITTS ratio?s purpose is to encapsulate how much of a slave we are to government and help us figure out whether we?ll ever have a chance of breaking free. The ideal TITTS ratio is under 50%.
Example 1: Bob pays a 20% effective tax rate and saves 25% of his net income. The ratio is therefore 20% / 25% = 80%. Bob is at the higher end of the range, but is still solidly saving for his future and living a decent life.
Example 2: Patty pays a 30% effective tax rate and saves 50% of her net income. The ratio is therefore 30% / 50% = 60%. ?Pretty good, and almost at my ideal level of 50% or lower. Patty just needs to continue tightening the screws by saving 1% more a month to get there.
Example 3: Lebron pays a 15% effective tax rate and saves 10% of his net income. The ratio is therefore 15% / 10% = 150%. ?Even though Lebron is only paying an envious 15% effective tax rate, he?s saving way too little to achieve financial security.
Example 4: Stephanie pays a 33% effective tax rate and saves 70% of her income. The ratio is therefore 33% / 70% = 47%. Stephanie comes in right at the recommended TITTS ratio of 50%. Stephanie is perhaps not fully utilizing her income to maximize the joys of life. Alternatively, Stephanie could be paying too much taxes and should seek to lower her tax bill by moving to a lower income tax state, developing lower taxed income streams, or moving out of the country.
Example 5: Sheila pays a 15% effective tax rate and saves 5% of her income. The ratio is therefore 15% / 5% = 300%. Sheila is up poops creek and will never be able to retire. This is the situation most of the world is in where we save too little and the government takes too much. At least Sheila is living it up and should count on the government to bail her out.
TITTS EXAMPLES IN GRAPHICAL FORMAT
10% Net Savings Rate
| Tax And Savings Guide: Total Income Taxes To Total Savings (TITTS) | |||
| Effective Income Tax Rate | Net Savings Rate | TITTS Ratio | Analysis |
| 5% | 10% | 50% | Excellent |
| 10% | 10% | 100% | Good |
| 15% | 10% | 150% | Average |
| 20% | 10% | 200% | Bad Donkey |
| 25% | 10% | 250% | Stinky Billy Goat |
| 30% | 10% | 300% | Horrendous |
| 35% | 10% | 350% | Stop Working |
| 40% | 10% | 400% | Dial 911 |
| 50% | 10% | 500% | Start A Revolution |
| Source: FinancialSamurai.com | |||
20% Net Savings Rate
| Tax And Savings Guide: Total Income Taxes To Total Savings (TITTS) | |||
| Effective Income Tax Rate | Net Savings Rate | TITTS Ratio | Analysis |
| 5% | 20% | 25% | Hero Status |
| 10% | 20% | 50% | Erecting A Shrine |
| 15% | 20% | 75% | Good |
| 20% | 20% | 100% | Getting Sloppy |
| 25% | 20% | 125% | Commoner |
| 30% | 20% | 150% | Skinny Rat |
| 35% | 20% | 175% | Poor Muskrat |
| 40% | 20% | 200% | Getting Robbed Blind |
| 50% | 20% | 250% | Why Bother Working? |
| Source: FinancialSamurai.com | |||
30% Net Savings Rate
| Tax And Savings Guide: Total Income Taxes To Total Savings (TITTS) | |||
| Effective Income Tax Rate | Net Savings Rate | TITTS Ratio | Analysis |
| 5% | 30% | 17% | Watch Out For The IRS |
| 10% | 30% | 33% | Call Yourself The Boss |
| 15% | 30% | 50% | Early Retirement Awaits |
| 20% | 30% | 67% | Still Winning! |
| 25% | 30% | 83% | Strawberries And Cream |
| 30% | 30% | 100% | Lemon Merengue Pie |
| 35% | 30% | 117% | Average Like the Sun |
| 40% | 30% | 133% | Rich But Poor |
| 50% | 30% | 167% | Slipping Away To Oblivion |
| Source: FinancialSamurai.com | |||
50% Net Savings Rate?
| Tax And Savings Guide: Total Income Taxes To Total Savings (TITTS) | |||
| Effective Income Tax Rate | Net Savings Rate | TITTS Ratio | Analysis |
| 5% | 50% | 10% | Watch Out For The IRS |
| 10% | 50% | 20% | Professional Minimalist |
| 15% | 50% | 30% | Early Retirement Awaits |
| 20% | 50% | 40% | Who Is Your Daddy? |
| 25% | 50% | 50% | Minimalist In Training |
| 30% | 50% | 60% | Winning |
| 35% | 50% | 70% | Pseudo Minimalist |
| 40% | 50% | 80% | What?s The Point Of It All? |
| 50% | 50% | 100% | Can?t Quit Fast Enough |
| Source: FinancialSamurai.com | |||
CONTROL WHAT YOU CAN CONTROL
It?s much easier to control your savings rate than your effective income tax rate when your main source of income is from employment. Your TITTS percentage should continuously decline as you save more and figure out ways to legally shelter your income.
Have no doubt the government will find a way to waste your hard earned money given it is spending your money on someone else. Why do you think the sequester went into effect? Our lawmakers don?t care because the sequester doesn?t touch their paychecks. You can be sure if our politicians were held to the same standard as the rest of us and got nothing until they did something, better policy will pass.
I?m convinced the majority of citizens will be able to achieve a comfortable retirement if they can get their TITTS ratio down to 50% or below. If you can?t, just blame someone else.
Readers, how are your TITTS? Are you gradually increasing your savings to improve your ratio? If not, is it because you love to work?
Note: I?ve been doing my own taxes with H&R Block for the past nine years if you are looking for a do-it-yourself tax software. I do my own taxes because I like to understand where my money is going and how I can better optimize my tax bill through pro forma analysis. Besides, how am I going to come up with a unique concept such as the TITTS ratio without doing my own taxes? Fight on.
Best,
Sam
Source: http://www.financialsamurai.com/2013/03/21/a-savings-and-tax-guide-titts-ratio/
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