What is your biggest living cost?

In most cases I believe the answer would be your income tax.  Unless you live lavishly beyond your means, in which case you have larger problems.

Think about it… the largest visible cost of living is rent/mortgage.  And the rule of thumb is not to spend more than 1/3 of your take-home pay on that.  Well if your take-home pay is a fraction of your total pay, then the cost of housing must be less than that as well.  Take a look at the tax bracket table or check out your pay stub and behold the horror.  If you are in the 25% tax bracket, you are only getting $0.75 for every dollar you earn.  I guess that is common sense, but it is pretty crazy to think about.

I have been researching income tax because I need to figure out the answer to the novel question of what to do with my positive cash flow.  Most “financial health” checklists start with “max out your 401K” right after paying off debts, etc.  I have always chafed at this notion because of my gripes about 401Ks: can’t access it until you are 60; employer match usually stops well below the contribution limit; 401K plans tend to have limited options and mysterious fee structures, blah blah blah.

But then there is the main advantage of 401K beyond employer match: pre-tax contributions.  100% of every dollar gets ported safely into the 401K.  Even if I were to dump a bunch of money into 401K and the market took a 20% hit tomorrow, there would still be $0.80 left out of every dollar rather than $0.75 out of every dollar if I let it come straight to me in my paycheck.  When I think about it that way, the luxury of letting my money come straight to me (even if my intentions are to invest it) seems rather extravagant.

If you can get around the 401K gripes (401K being the only sensible way I know to divert pre-tax money), this seems like a highly logical thing to do for the tax benefit.  Yes, you still get taxed later when you take the contributions, but at a much lower rate based on realized income.

Is there something I am missing…?  I always hear that the rich understand to reduce their taxes.  I would think it should start now, with this kind of thing…

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