Have you ever gone to Walmart on a Wednesday morning and seen tons of people? I always wondered how these people would be away from work at this time.
I worked for the United States Marine Corps for 24 years, during which I never had time to go shopping throughout the day. I was stuck at work for 10-12 hours straight.
Many people use the government or family to escape the workforce, but a few use passive income to free themselves.
My Recession Investing Plan
Today, I want to show you the earned income trap for what it is and give you a way to sidestep it. However, it will take great work and imagination on your part to see a different path.
What is earned income? Earned income is money you receive for exchanging time for money. Some types of earned income are wages, tips, salaries, gig work, and self-employment income.
Earned income has the distinction of being the highest taxed income you generate for yourself. Not only do you pay high federal and state taxes, but you also pay social taxes such as Social Security and Medicare.
Most of us start our working lives as earned-income employees for a small business, corporation, or government. We do this because we need to start paying bills and buying liabilities (cars, clothes).
What is the earned income trap? The earned income trap becomes apparent as you make more money. The more money you make, the more you pay in taxes.
What is Your Dream Retirement?
America has a progressive tax rate, meaning the more you make, the higher percentage you pay. Also, the more you make, the more tax credits like the earned income and child tax credits phase out.
As you build your family and buy a house, these higher taxes can really put a strain on your cash flow and happiness.
In my last year of working full-time, I paid a ton of taxes. I had nowhere to hide. Luckily, both my kids were underage, and I could draw the child tax credit.
If you don’t know how to earn additional income, from outside (non-earned) sources, you’ll be stuck in the trap until the end.
What are the other types of income? To sidestep the earned income trap, you must first learn the different types of income. Once you understand these, you can move on to more advanced measures to protect your money.
Your 401K is NOT Enough
The three types of income are earned, portfolio, and passive. The ultimate goal is to convert your earned income into the other two types.
Portfolio income comes from paper assets such as dividend-paying stocks, capital gains, bonds, options trading, and paper commodities.
Passive income comes from hard assets such as real estate, royalties, residual business, and commodities.
Converting earned income into portfolio income. I am a massive fan of dividend investing; however, receiving a decent amount of cash flow requires a lot of money.
If you are starting with zero paper assets, you’ll require a strict budget. Let’s say you earn $5,000/month from your restaurant job. Your goal is to save at least $1,000/month in dividend-paying stocks like Verizon (VZ) and AT&T (T).
Home Maintenance Fund vs. Emergency Fund
As you slowly invest in these blue-chip companies, you’ll receive money back in the form of dividends. If you keep at it, you’ll have enough money from dividends to cover your expenses. You’ll be financially free.
Dividends give you certain tax breaks. If you make around $100,000 as a couple, you’ll pay zero taxes on qualified dividends from blue-chip companies. Remember, you also won’t pay social taxes.
You’ll also receive tax breaks on long-term capital gains. Some municipal bonds avoid federal tax, and government treasuries don’t require state taxes.
The moral of the story is that investing in portfolio income will eventually set you free while allowing you to pay fewer taxes.
Converting earned income into passive income. Passive income from real estate is one of the best ways to lower your tax bill. The main reason is the depreciation of your hard assets.
Home Equity Loans vs. Interest Rates
Real estate is similar to a business in that you pay all of your expenses first and then pay taxes. Depreciation is an expense.
Suppose you have a $500,000 duplex that generates $100,000 in gross revenue (before taxes). You can write off mortgage interest, property taxes, management, maintenance, utilities, and depreciation. Your write-off will probably be more than the $100,000 in revenue, mainly because of deprecation.
As you work with tax experts, they will guide you on how to keep your taxes low. Once your property finishes depreciating (27.5 years), you can sell it and roll it into another property with a 1031 exchange.
Starting a business is another good way to pay less taxes. Let’s say you purchase and install a vending machine on a property.
Are You Ready to be a Landlord?
You can expense your food costs, maintenance, driving, vehicle, and utilities. You have many tools to ensure you extract as many expenses as possible before paying taxes.
Move as an insider. Most people get stuck in the earned income trap because they are outsiders—they cannot control their income.
Outsiders wait for their boss to give them a promotion. They work additional hours even though they are on salary. They can’t control one aspect of their financial lives.
The key to avoiding the earned-income trap is to become an insider. This means you are the one buying the vending machine.
If you want to earn more business revenue, you can buy higher-margin foods, lower your purchasing prices, move locations, or add more machines. You are in control of your financial destiny.
How We Plan to Retire on Dividends 4
The first step of getting out of the earned income trap is earning money in a different income type. You can become a dividend investor, options trader, content creator, or Airbnb host.
As you dabble in your new world, you’ll discover how exciting it is to have options and control. If you continue adding more income streams, you’ll eventually retire as a financially free individual.
Conclusion. We fall into the earned income trap right out of high school or college. But that doesn’t mean we must stay as wage earners our entire lives.
The toughest part of overcoming the earned income trap is believing in the other types of income. School taught us that earned income is the safest, but the opposite is true.
Self-Storage vs. Recession
Again, you have no control over the earned income bracket. You depend on someone else to give you a paycheck.
The better option is to create your own paycheck from dividends, rents, royalties, and residual business income.
The two easiest and most effective ways to change your mindset are to start investing in dividends and open one of your rooms from rentals.
These two things will show you the power of portfolio and passive income. Once you get a taste, you’ll be hooked. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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