Benjamin Franklin said, “Nothing is certain except death and taxes.” If you are anything like I was in my twenties, you didn’t think much about either. While both may be certain, one is unavoidable and the other can be limited. Working with a CERTIFIED FINANCIAL PLANNER™ professional as early as in your twenties can put you ahead in meeting your long-term financial goals.
Here are a few tax tips to follow in your twenties:
- The Advantage of Tax Advantaged Savings
By making contributions to a 401(k) or an IRA, you can lower your taxable income for the year and contribute untaxed dollars into investment accounts. You will pay less in taxes for the current year and have more dollars to invest. For example, if you earn $50,000 and you contribute $5,000 to an IRA or a 401(k), you will now have a taxable income of $45,000 for the year and the full $5,000 will be invested.
Making contributions to a health savings account (HSA) is just as powerful as saving in an IRA or 401(k). To utilize an HSA, you must be enrolled in a high deductible health plan (HDHP). An HDHP is a type of health plan where an individual is responsible for paying higher deductibles and max-out-of-pocket expenses compared to more traditional plans such as HMOs or PPOs. However, because most people in their twenties are healthy, it is unlikely that you will need any major medical care. An HSA works very similar to an IRA, but instead of paying for retirement costs, it covers qualified health care expenses. You can contribute pre-tax money up to $3,650 if you are single or $7,300 for a family plan in 2022.
- Good Debt Gets Better
Thanks to our tax code, good debt, like student loans and mortgages, get even better when you can deduct interest. For many college graduates, the first priority in post-graduation financial planning is tackling student debt. First, find out how much you owe, who you owe it to (government or private loans), and on what terms. Then calculate how much interest you will pay, and how much of that money you can deduct from your tax return. You will also receive an IRS Form 1098-E from the student loan lender each year that specifies the exact amount you paid. Depending on your income, you may be able to deduct up to $2,500 on your tax return; because this is an above-the-line deduction, it is deducted directly from your gross income.
- Mortgage Debt
Buying a home is one of the best ways to build wealth and minimize taxes, but you must understand it will impact your overall finances. Our current tax code allows for a tax deduction on any interest paid on a mortgage up to $750,000. If you borrow $350,000 at 4%, you can expect to pay roughly $13,880 in interest your first year. All of this interest counts as a below-the-line deduction, and is an itemized deduction as opposed to a standard deduction. If you are single, the standard deduction is $12,950 in 2022, and for married couples, it is $25,900. You will only be able to deduct your mortgage interest if you itemize, and you can only itemize if your deductions are greater than your standard deduction. If you can itemize, you can also deduct items such as state and local taxes (up to $10,000) and charitable gifts. These items along with mortgage interest can help create a lot of tax savings.
- Learn About Taxes
Many young people believe that you have to be wealthy to worry about taxes. But having a successful tax plan is important for all income levels. It is important to understand how taxes work and how much you need to pay as you make a plan to reach your financial goals.
The amounts we discussed all seem small incrementally, but over time, they can make a huge difference. Think about what would happen if you decided to save, contribute, and deduct certain amounts each year from the accounts mentioned above. What impact might it have on your taxes? With the help a CERTIFIED FINANCIAL PLANNER™ professional, you can find the tax planning methods that work best for you. For more tax savings tips, visit LetsMakeAPlan.org.