Found this article, http://finance.yahoo.com/taxes/article/108058/10-ways-to-lower-your-taxes?mod=taxes-advice_strategy which I thought was handy and worth sharing. Anyone else have any handy nuggests of advice on how to cut down on personal taxes?
These ten ways to lower taxes are a good start, but one of them (#1) could actually increase your taxes and the person who wrote the article left out a some good ideas and did not go far enough in explaining the downside of some of these tax savings ideas.
Boosting your 401(k) contribution does lower your taxable income now, but the reduction is only temporary. The taxes are deferred, not reduced. If you follow the tip to max out your 401(k), the accumulated deferred account will be larger at retirement time, causing larger Required Minimum distributions, and pushing you into a larger tax bracket at retirement time. This Required Minimum distribution gets added to Social Security, interest income, dividends, and any wage income you may have. This could cause your Social Security benefit to be taxed, (if married, adjusted gross income of between $32,000 and $44,000 requires you to report 50% of your SS benefit as income and over $44,000, 85% of the benefit needs to be reported.) This combined with the tax on the 401(k) could cause you to pay more taxes at retirement time than you are paying now. You need to sit down and do the math to verify that maxing out your 401(k) is a smart tax savings move. Make the most of your flexible spending account. Just make sure the amount you choose is completely spent. Any money left in the account is forfeited. This amount could be greater than the tax savings. Sell losing investments. You need to make sure the losing investment is not one that will recover later. Using losses to offset gains is a better deal, because if you lost $100,000, and had no gains to offset it, you will need over 33 years to write off the loss, (maximum of $3,000 per year can be deducted,) assuming you have no more losses. Give to Charity. This is the best tip. I have a lot of clients who give items to the Salvation Army or Goodwill and don’t take the deduction on their taxes. You can save a lot of tax by giving things of this type to charity. The deduction can be much greater than having a garage sale. Keep track of medical expense. Most people don’t qualify for this deduction. If your adjusted gross income is $100,000, you need $7,500 of medical expense before you get $1 of tax deduction. But, it is worth keeping track of this expense, because you just might qualify. Now here is what the article failed to mention:
Don’t let money compound in interest bearing savings accounts. The "magic of compound interest" causes "the magic of compound taxes." If you had a savings account with $1000,000 for the next 30 years at 3%, you would have $242,726 at the end of 30 years, and would have paid $35,682 in taxes. This tax is called a lost opportunity cost, because once you pay the tax to the government, you have lost any opportunity to do anything else with it. If you could have invested the tax expense at an after tax rate of 2% you would have earned $11,435. So your tax cost and LOC cost combined is $47,116. But what if you took the interest from the account each year and put it in a Roth IRA earning 3%. You would still have the same balance at the end of 30 years, $100,000 in the savings account and $142,726 in the Roth ($242,726) but the tax would have only been $21,843 instead of $35,682. ($13,839 tax savings). The LOC would have been $8,286 instead of $11,435. You would have saved $3,149 in LOC. So you would have accumulated the same amount of money, but you would have saved $16,988 in tax and LOC. Don’t reinvest dividends in mutual funds or stocks. Same reason as above. Dividend reinvestment is the same as compound interest. As the account gets larger, the dividends get larger, (assuming no down market,) fees get larger, and the tax get larger. If the dividends are removed and put into a Roth with a low risk investment allocation, then if the market drops, your dividends are protected because they are no longer in the investment. Invest or save mortgage interest tax deduction. Most people tax deduct the interest paid on their mortgage, but most people do not take the tax savings, (amount of your tax return allocated to mortgage interest.) For example a $300,000 dollar mortgage at 5% will cost you $279,767 in interest. In a 25% tax bracket, the value of that interest deduction is $69,942. Invested at 3% in a Roth or some other tax free account, the value of the tax savings would be $126,857 over 30 years. Just because someone gives tips about ways to save money on taxes, it is imperative that you apply the tips to your specific situation to determine whether the tips will create more tax or less tax over your lifetime. There is no sense taking some tax saving tip advice, only to find out later that will cost you more in taxes because you followed the tip now as compared to doing something else.
The best way to get out of debt is by keeping expenses lower than income and use any low interest-bearing savings account money to pay off higher interest credit cards. Avoid the pitfalls of debt with tips from a financial planner in free personal-finance video.
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