Who Likes to Pay Taxes?
Steven Beck, AWMA, AIF
Anybody? I'm sure there aren't too many people that enjoy paying Uncle Sam a portion of their hard-earned income every year. As Benjamin Franklin once said in 1789, "There are only two certainties in life, death and taxes". And how true that statement is, even hundreds of years after he said it. While there is no way to escape taxes, there are ways in which you can lower the amount of taxes you owe every year.
One fairly strait forward way to lower your tax bill is through qualified retirement account contributions, such as investing in an individual retirement account (IRA). Anyone with earned income can take advantage of this deduction, and opening an IRA is often free. The amount you add to a qualified plan, up to the account type limits, will lower your taxable income by an equal amount. For instance, if you earned $100,000 and contributed $5,000 to your IRA in 2019, your income taxes will be calculated on the remaining $95,000. You can "deduct" that $5,000 contribution from your income that year. The dollar amount you ultimately save in will be determined by the marginal tax bracket you fall in to:
And for those in California, we also get to pay state income taxes in addition to federal income taxes:
There is nothing we can do about the tax rate (putting aside voting and other political options for this discussion), but we can help determine how much of our income is subject to tax. For instance, take John, a single person living in California making $60,000/year. If he were to contribute $5,000 to an IRA, he could save $1,656 in taxes! This is calculated by multiplying the $5,000 contribution by his state and federal marginal tax brackets of 22% and 9.3% respectively. Alternatively, a married couple with $160,000 in annual income could save up to $3,756 if they each fully fund an IRA!
In addition to the annual tax savings, putting aside money for your future is never a bad idea. With the average social security recipient receiving only $1,461 a month, according to USNews, most people will need to supplement their retirement income with additional savings to help ensure a comfortable retirement. If you manage to save the $5,000 a year, not only can you potentially save thousands of dollars in taxes, but your IRA savings could be worth over $200,000 in 20 years!
Now, imagine that after 20 years, you decide to retire. Assuming a 5% rate of return in retirement (it usually makes sense to reduce your risk once you're in retirement, thus likely a lower rate of return), you may be able to withdraw up to $18,000 annually for nearly 20 years. That's over three times the amount that was invested, over a same 20 year period!
Between social security benefits and IRA savings from the example above, your monthly retirement income could be up to $3,000 a month. While this most likely will not be enough to fully fund a comfortable retirement, it will give you a good start. The most important part about saving is to just get started. Once you begin, increasing your monthly contributions every so often should seem much more manageable, as you work towards providing yourself the retirement income that you need to sustain a happy, healthy retirement.
The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. This example does not represent any specific product, nor does it reflect sales charges or other expenses that may be required for some investments.
This is meant for educational purposes only. It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.