During your younger years, deciding where to direct your hard-earned paycheck can be a struggle. Especially for those starting out in their career, it’s nice to have a steady paycheck coming in, but it can also be overwhelming because you have many options when figuring out what to do with that income.
Should the money be used to pay down debt and student loans? Should you work on building an emergency fund? Start saving for retirement? What about the fact that you want to buy a new car soon or may need a down payment for a house?
As your personal finance goals evolve, it becomes increasingly important to make sure you are keeping as much of that income in your “pocket” as you can. For that reason, we are going to talk a bit about income tax planning today.
You can do a few relatively simple things to help keep more of your income working for you rather than sending it to the IRS. The bonus is that these strategies are also great for helping to make sure you are on track to reaching other goals you may have.
Contribute to a 401(k) or IRA
Contributing to a retirement plan like a 401(k) or individual retirement account (IRA) can be one of the easiest ways to reduce your taxable income. At the same time, it can have the biggest impact on helping you achieve your retirement goals.
Your specific circumstances will help determine which route to take when deciding whether you should make traditional and/or Roth 401(k) or IRA contributions. There are benefits to both 401(k) and IRA plans, and either way, the fact that you’re saving for retirement is key.
Generally speaking, if you make traditional 401(k) or IRA contributions, you are going to enjoy tax savings today. If you opt for the Roth 401(k) or IRA, the tax benefit will come in the future, when you need to start drawing on those funds (hopefully in retirement).
Update Your Tax Withholding
Making sure that you are withholding the appropriate amount from each paycheck will help to ensure you don’t have a big bill at tax time. It will also help make sure you get more of your money throughout the year, when you earn it.
To see what would be a reasonable amount to have withheld, you can use the IRS Tax Withholding Estimator. Once you have your results, you can file a new W-4 form with your employer (check with your HR or payroll office) to have your withholding updated.
Contribute to a Health Savings Account or Flexible Spending Account
If your employer offers a flexible spending account (FSA) or health savings account (HSA), consider diverting part of your salary to one to help pay medical bills.
Not all employers offer FSAs, and you will need to be part of a high-deductible health insurance plan to be eligible to contribute to an HSA. However, if either of these accounts is available to you, make sure you consider them. Both accounts are tax-advantaged; you avoid income and Social Security tax on the money you put in.
Take Advantage of Tax Deductions
If your student loans qualify, you may be able to deduct up to $2,500 in interest you paid on your loans during the year.
Are you a teacher? You may be able to deduct up to $250 of unreimbursed expenses you incurred related to your job.
Did you have education expenses? You will want to check to see if you might be eligible for education-related tax breaks like the American Opportunity Tax Credit or Lifetime Learning Credit.
Consult a Professional
There are a lot of rules related to understanding the tax code and figuring out the tax planning strategies that might be best for your situation. There is no one “right answer” for everyone, and with the IRS, there are often rules regarding eligibility when it comes to tax savings.
For this reason, it can make sense to hire a tax professional like a CPA (Certified Public Accountant) or consult with a CERTIFIED FINANCIAL PLANNER™ professional to make sure you’re taking advantage of all the tax savings opportunities available to you without making the IRS mad!
Contact us for a complimentary needs assessment phone call.