Tax-Advantageous Things to Do With Your Money
Many people think of money as linear—it comes in, it goes out. It's associated with immediate need or gratification. Sometimes you save a little. In fact, money is multi-dimensional. It can do more than one task at a time—like create future savings and security and simultaneously shrink your taxes. Many of us just need to learn to think of money in terms of delayed gratification and making our dollars do more. So here are some ways to save on taxes by smart use of your money.
Be prepared; this can only point you in the direction of smart money use. The rules and math may change depending on your circumstances including marital status, age, income, as well as many other factors. Multi-dimensional money can get complicated. However, it's never too late to start understanding how it works.
Max out your tax-deferred investments
The best time to start saving for the distant future is right now. However volatile the stock market might be, consider that a person who bought 100 shares of IBM stock in 1998 for $4,000 could have sold that stock in 2018 for $21,000. It may have gone up and down in the meantime, but ultimately, it has risen significantly. Retirement accounts are a common way to invest in the future. They take money from today and invest in things that it's believed will increase in value. Moreover, they reduce their taxes at the same time.
So, let's say you have:
- A regular corporate 401K
- A 403b (employees of schools and some charities)
You tell your employer or your plan administrator how much you want them to take out of your pay (before taxes!) and put into your account. So long as you still have enough to live on, the more you authorize them to take the better, up to a legal limit. People under 50 max out their contribution limit to a 401K or 403b with $19,000 while those over 50 can contribute more.
Some employers only let people change their contribution amount once a year, while others let them change it as much as they want.
What if you have money left over or don't have a company retirement plan? You may be able to set up an Individual Retirement Account (IRA) or Roth IRA where you can tuck extra money, up to $6,000 or $7,000 if you're over 50. If you're self-employed, you could establish a Self-Employed Pension (SEP).
There are many types of retirement plans. The tricky part is there are a LOT of terms and conditions around each one, so make sure you know what the rules are before you put your money in a particular account.
The good news is that this plan helps you in several ways. The contributions give you a tax deduction—a reduction of your taxable income—that's calculated by multiplying your tax percentage by your contribution. If you're in the 25% bracket, for example, and you put in $5,000, you may be eligible for a $1,250 tax break. Also, these investment types offer a tax credit—depending on your income and other factors. Unlike deductions, tax credits are a dollar for dollar reduction of what you owe. For example, everyone who is eligible for a $2,000 credit gets a $2,000 reduction of their tax bill. That's multi-dimensional money handling.