Saving money on federal and state income taxes doesn't have to be a complicated process.
Tax Savings With The Help Of Your Employer
If you get a paycheck and a W-2 in the spring, your employer takes out your income taxes per your instructions on your W-4 and makes the payments on your behalf. If you're single and have no dependents, you should claim single and zero or single and one.
To Refund Or Not To Refund?
For people who struggle to save, a nice big tax refund in the spring can be sweet. You can use it to pay down debt or save it for a summer vacation.
However, a tax refund can also be viewed as a loan that you made to the government for which they paid you no interest. If this seems inefficient, consider adjusting your W-4 withholding and setting up a savings account in an on-line bank.
This bank will automatically place a portion of your pay into a savings account. Depending on the on-line bank you use, you can set up restricted accounts with a required dollar amount for vacations and holidays.
You'll earn interest on your deposits over the year and won't feel the pinch of the loss of your tax return. The most efficient method of tax withholding is to break even in the spring.
Tax Savings With A Retirement Account
If your employer offers a 401(k) with an employer match, be sure to participate and have at least enough withheld to capitalize on the match; doing anything else would be like walking away from a raise. If you can swing it, consider meeting the maximum withholding on your 401(k) from the start. This money is withheld pre-tax, so you won't be counted as income on your W-2. You will need to pay taxes when you withdraw it.
Another pre-tax withholding option is the medical flex plan. If you have regular medical expenses that you need to pay on a monthly or yearly basis, you can make those payments with pre-tax dollars. Please note: some flex plans require that you use all the money at the end of the year, or you'll lose your contributions. If you don't have regular expenses, a flex plan may not be your best choice.
Consider setting up a Roth IRA for your future retirement planning. Roth IRA's are made with post-tax investments, so you don't have to pay income taxes on this money when you withdraw it after the age of 59. Additionally, if you wait five years after setting it up, you can withdraw up to $10,000 from your principal contributions for a down payment on a house.
Once you're ready to invest in real estate, consider purchasing a duplex or a twin home. This will provide you with a place to call your own and an investment property that you can closely monitor, and you can take depreciation deductions on a portion of the property over time, as well as deductions on any improvements you make. Your renter can help cover your mortgage payment.
Tax Savings On Self Employment Income
Whether you're 100% self-employed or building your side hustle, be aware that your tax responsibilities do not change. In fact, they're increased. You need to pay all of your own Social Security and Medicare Taxes (if your employer withholds taxes, they pay half.)
Put aside 20% of your side hustle income for taxes. If you're going to make more than $10,000 from your self-employment job, talk with a tax professional about making quarterly estimate payments to avoid penalties.
Break The Paycheck To Paycheck Habit
If the idea of saving for retirement is a bitter joke because right now you're saving for lunch at the end of the month, consider the following tips to reduce expenses and set the stage for saving some of your hard-earned money.
- Go back to cash, and track it in a notebook. It's easy to put expenses on your credit card until you get a shock when you open the bill. Cash hurts as soon as you spend it if you're spending more than you need.
- Build a "free-kend" into every month. Visit a museum on free day or check out a concert in the park. Skip restaurants. If you think you can't cook, go to your local library and pick up a few simple cookbooks. One-dish meals are easy to put together and often leave leftovers that you can enjoy the next day.
- Spend in balance. Don't burn cash on alcohol and junk food if health is important. Don't waste money on a premium cable package if TV fills up your creative time.
Getting a grip on your spending is the first step in building investment and retirement savings. Once you know where your money is going, you can start directing it most effectively for your life.