Every year I do my best to minimize my taxes without reducing my income. Most people think that they do this. However, most people go through the year spending and earning money without much thought as to how it impacts their tax situation. Then, come April next year they hire an accountant or use some tax software to figure out how to minimize their tax burden. Like everything else in life a little planning can go a long way. I start trying to work out my tax situation at the beginning of the tax year. My main goal every year is to hit the limit for the saver’s tax credit.
Saver’s tax credit
This sounds like exactly the sort of tax credit an aspiring Thousandaire should want. It might as well be called the Thousandaire tax credit. Basically it is a tax credit for a portion of the money set aside for retirement. Essentially it is the government 401k match. It matches depending on your income between 10% and 50% of your retirement contribution. It only counts the first $2000 of your retirement contribution as well. If you meet the 50% income limit and contribute $2000 you get a $1000 tax credit. It is substantially easier to make the income limit for the 10% credit. This is one area of the tax code where it pays to get your income exactly right. Make even a dollar more than the limit and you pay hundreds extra in taxes. So, in order to take advantage of this we have to aim our income pretty carefully.
|Saver’s Tax Credit||10% credit||20% credit||50% credit|
|Single and Married Filing Jointly||$30,500||$19,750||$18,250|
|Head of Household||$45,750||$29,625||$27,375|
|Married Filing Jointly||$61,000||$39,500||$36,500|
The good news is that the saver’s tax credit doesn’t check your gross income, but rather your adjusted gross income. What’s the difference, I hear you ask? Well the difference that we care about is that the AGI is your income after 401k, traditional IRA, and HSA contributions have been accounted for. So if your gross income is $40,000 and you contributed $10,000 to your 401k then your AGI is at most $30,000. Step one to reducing your taxes significantly means figuring out what level of 401k contributions are necessary to get below the desired income limit for the Saver’s credit. Make sure you include the impact of possible raises and bonuses (or bump your 401k contribution up by the amount of the raise when it arrives, this is probably good practice anyway). If you find that your income is too high (my heart bleeds for you) you can squeeze another $3,000 out of an HSA, giving you $20,500 of reach to get your AGI below one of the Savers breakpoints. In principle you could use a traditional IRA to get an extra $5,500 of reach but at these income levels I’d guess you’re better off with a Roth. Obviously if you are only off by a few hundred dollars contribute that amount to a traditional and the rest to a Roth, but if we’re talking about using up all of your IRA space, I’d say don’t do it.
All of these tax shelters essentially mean that, for single people making less than $50,000 per year US income taxes are consumption taxes rather than income taxes. Income you don’t consume can and should go into tax shelters.