Bob O'Brien
Head Instructor
bobrien@mywealth.com
I have prepared all sorts of tax returns for the young and old, affluent and less affluent, middle class and every other class. I have to say one of the most heavily taxed demographics is the twenty- somethings and those in their early thirties and single. Unfortunately, not enough of them are recognizing it. I can’t tell you how painful it was when I would see them get hit hard with taxes and not take advantage of a tax sheltered account like a 401k or Traditional IRA.
This demographic is usually single and they usually do not own a home. This is where all the major deductions are found that lead to other deductions.
Take a look at the single brackets and check out how quickly, you can get into the 25% bracket when you are single.
|
Single
|
||||
|
Taxable income is over
|
But not over
|
The tax is
|
Plus
|
Of the amount over
|
|
$0
|
8,025
|
$0.00
|
10%
|
$0
|
|
8,025
|
32,550
|
802.50
|
15%
|
8,025
|
|
32,550
|
78,850
|
4,481.25
|
25%
|
32,550
|
|
78,850
|
164,550
|
16,056.25
|
28%
|
78,850
|
|
164,550
|
357,700
|
40,052.25
|
33%
|
164,550
|
|
357,700
|
|
103,791.75
|
35%
|
357,700
|
If you earn over $32,550 a year, you are paying taxes at the 25% bracket (not including state taxes). If you live on one of the coasts, then you could incur another 8% to 9% in state tax. In a nutshell, you may be paying well over 40% in taxes on your money.
Why is this demographic is hit harder than others?
Because they generally do not have the major deductions, that the mid thirty-somnethings usually have that go along with having children and a home. Mortgage interest is tax deductable and allows you to itemize… which leads to other deductions once you start itemizing. Having children also helps when it comes to taxes, due to exemptions and additional tax credits that you get. Taking all of this into account, you will quickly see that most “twenty-somethings” generally do not have enough tax deductions in order to itemize.
What’s the remedy for these twenty-somethings?
Make certain you are getting the deductions that will generally apply to you, and by all means…take advantage of tax sheltered accounts like 401k’s and IRA’s. Also refer to my blog Invest some Tine in Knowing your Taxes!
Student loan interest and education expenses are two popular deductions for this demographic. So make certain that you understand the rules and are maximizing these deductions.
Here are a couple of links that will help you with those deductions.
Now I want to focus on a tax a strategy for you that should help you to maximize your tax savings, increase your tax IQ, and of course, help build wealth and financial security. I can’t stress enough, the importance of taking advantage of either an IRA or 401k for this demographic. If you need to spend less to do so, you will certainly not regret it! In the end, you are helping yourself.
The Strategy
Many people in this demographic, are offered a 401k and can do a Roth IRA on their own as well. First of all, if you get a matching contribution from your employer in your 401k then it’s a no brainer to take advantage of that “free money”.
This strategy applies to your tax bracket and how much to allocate to a 401k and Roth IRA. Use your tax preparing programs to do a rough projection and determine what amounts will be taxed at the higher 25% bracket (or higher) and allocate that to a 401k in that tax year. Once you are in the lower bracket allocate the rest of the money to a Roth IRA. In other words, once you get your “taxable income” (not you’re “earned income”) below $32,550, you are in much lower bracket and therefore should also take advantage of the Roth IRA.
Remember a 401k/Traditional IRA save you taxes now and a Roth IRA saves you taxes “later” because the Roth IRA is never taxed assuming you stay within the rules. (In a Roth IRA, you pay taxes now, but the money grows “tax free”). The 2009 401k limit is $16,500 and the Roth is $5,000.
Finally, we have not even begun to talk about all the other benefits of doing this and taking advantage of these types of accounts. The other advantages are: it starts your saving and investing early. Your interest compounds which makes wealth building easier.
In conclusion, even if this strategy does not work well for you for whatever reason, it may spur on another strategy that may work real well for you and add to your tax savvy. If you are serious about building wealth, you need to understand your taxes because it will be one of the largest expenses of your life!
Please share any thoughts or comments, and also check out our courses!
Bob O’Brien
Sr. Instructor
