A young high income earner is particularly hit hard by the prevalent tax regime in the U.S. However, a young high income earner can exploit a number of tax-advantaged saving plans to both circumvent today's tax and enjoy in the future the compounding power of money. I would rank these plans according to their tax saving power.
1. HSA. The only plan I have known that you can contribute pre-tax $$$, grow the balance tax-free and withdraw $$$ tax-free. I would recommend youngsters to contribute to the upper limit and invest $$$ in the stock market. In this country, healthcare cost is only going up. You will need every dollar in this plan to pay your medical bills when you are getting older.
2. Mega 401K plan. If you are one of the few lucky guys who are offered Mega 401K plan, don't hesitate to go on with the plan. Three different contributions are available under a mega 401K plan: pre-tax contribution 401K, after-tax contribution investment, and after-tax Roth 401K. In combination, you may put aside up to $50K+(including all $$$) in this plan, depending on IRS' rules.
a) Pre-tax contribution 401k. You contribute pre-tax $$$, grow the balance tax-free, but you will have to pay tax on every dollar you withdraw at ordinary income tax rates. Usually employers match $$$ you contribute, but to an limit.
b) After-tax contribution investment plan. You contribute after-tax $$$, grow the balance tax-free, but you will have to pay tax on invesment earnings when you withdraw The plan is not very interesting because it locks up your capital, and you will have to pay tax on every dollar anyway.
c) After-tax Roth 401K. You contribute after-tax $$$, grow the balance tax-free, and withdraw $$$ tax-free.
Please note that currently conversion from after-tax contribution investment plan to Roth 401K is allowed. The conversion is called back door Roth 401K conversion. When converting, you will have to pay tax on investment earnings at prevalent tax rates.
The strategy I recommend is to fund the pre-tax contribution 401K plan to the extent that you can get all matching $$$, thereafter fund the Roth 401K plan as much as you can, and subsequently fund after-tax contribution investment plan to as much as you can then convert all $$$ to the Roth 401K before you earn anyincome or capital gains. This way, you won't pay any tax on investment earnings.
3). If you are not offered a mega 401K plan, you can fund a Roth IRA plan, as long as your income qualifies you to do so. It is likely that your income is too high to qualify, a back-door Roth IRA conversion is still available. The mechanism is similar to the above, funding a contributory IRA plan and convert it into a Roth IRA plan right away.
After paying into all these plans and paying all your bills, congratulations if you still have $$$ left. What are you going to do with $$$? I would say buy the best companies in the US, keep these stocks in your brokerage account and forget about it. One day, if you are unemployed, you may sell some stocks to make a living.
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I have spent too much time on unsubstantive discussions on this forum. I appreciate the good time that I have been sharing with you. Honestly I have learned a lot from you. However, life is short. In the future, I would rather focus on one or two things I really enjoy doing. Please come to my blog and share my English writing about the books I have read. Thanks in advance!
Hopefully A-mao will like my post above.
