It's Not Fun, but It Has to be Done Benjamin Franklin wrote a 1789 letter that states, “But in this world nothing can be said to be certain, except death and taxes.” Even at the United States’ early beginnings, federal taxes were a necessary evil to fund various public projects and administrative costs. Today, federal taxes serve much of the same purpose. While virtually no one likes to prepare and file their taxes, it is a necessity if you want to avoid fines and further hassle. It is no secret that preparing and filing your taxes is notoriously complicated. Many people lament that it should not be so difficult to pay the government. However, some of the complications allow people to save money if they discover specific tax benefits. Knowing how to file your own taxes may be a good option if your tax situation is relatively straightforward, or if you are willing to learn the process. Why Do You Need to File Your Taxes Every Year? The short answer is that federal law requires that most individuals file taxes annually. Income taxes are assessed every year based on your income earned during that period. You then pay a percentage of that income to the government, less any deductions, adjustments, or credits that you qualify to receive. If you do not file (and pay) your taxes, then you may be assessed penalties and interest. The Internal Revenue Service (IRS) can even go as far as garnishing your wages and repossessing your property if you do not file and pay as required. The Benefits of Filing Your Own Taxes If you are one of the 43% of Americans that are doing your own taxes, you are certainly not alone. Roughly 53 million people prepared and filed their own taxes in 2018. There are many benefits to filing your own taxes, including: Saving money: Hiring a tax professional is expensive, and many people can prepare and file their returns on their own, completely free of charge. Control: Some people like knowing the exact information that is included in their return and being able to control the data, and for some, knowing precisely how the numbers work out, is comforting. Gain helpful information: When you prepare your taxes, you can see what items saved you money this year or which issues you should address so you can save money next year. While filing your own taxes is complicated, it can be beneficial under the right circumstances. There are several programs online that walk you through the process to help ensure you are taking advantage of all of your available deductions and credits. The Drawbacks of Filing Your Own Taxes In addition to the benefits, there are also some disadvantages to filing your own taxes. These include: Time and effort: Preparing and filing your taxes takes time and work You have to sift through financial information and deal with concepts that you may not understand well. The process can be frustrating and take a considerable amount of time. Error risk: If you do not completely understand how your taxes work, you run the risk of making a mistake because of misconceptions. If that happens, it could lead to underpayment and audits down the road. Questions: Even if you use a tax preparation software, you may still have questions that will remain unanswered unless you do significant research or reach out to a tax professional. For some people, the risk of having a substantial error that triggers the IRS’s attention is enough to scare them away from preparing their own taxes. Preparing for Filing Your Taxes When you begin work on your taxes, you should have information gathered throughout the year. Some of the most common items that you will need include: Social Security numbers for you, your spouse, and any dependents Information about wages, such as W2s or 1099s Investment income information Documents that represent any other source of income Information regarding adjustments to income, such as student loan interest paid, IRA contributions, and health savings account contributions, just to name a few Information regarding potential credits, including, for example, child care expenses, education expenses, or retirement savings contributions Data about any tax payments that you may have made throughout the year Keeping good records will help make tax preparation easier at the beginning of the year. [youmaylike] The Basics About What You Can Claim When Filing You must pay income taxes on all your income earned throughout the year. However, that income is reduced by a few things. The further you can reduce your taxable income, the less you tax you will pay. There are three general categories of tax reduction methods: Standard or Itemized Deductions Everyone can claim either the standard or itemized deductions. Standard deductions are a set amount that is based on your filing status. Itemized deductions are based on actual expenses that you incurred throughout the year. You can choose to use the higher deduction. The higher the deduction, the less tax you will have to pay on your income because your income decreases on paper. Itemized deductions include things like medical expenses, state and local tax payments, and home mortgage interest deductions. Itemized deductions will only decrease your income by a certain percentage, or up to a specific point. Adjustments Some adjustments to your income may also be available. These include things like paying student loan interest or alimony. Adjustments are more valuable compared to deductions because they decrease your income dollar for dollar. Credits A credit decreases your taxable income as well. Some credits are refundable while others are not. For example, you get a child tax credit simply for having children that qualify for that credit, but that credit will not be paid out to you if you do not have any tax obligations. On the other hand, the Earned Income Credit, which is available for low-income filers, will be refunded to you even if you do not owe any taxes. There are a wide variety of deductions and credits available. Take a look at the federal forms and related schedules to determine whether you might qualify for any of these. How to File Your Own Taxes If You Live Overseas If you earned income in the United States as a U.S. citizen or resident alien, you likely need to pay taxes on that income. This is true even if you live overseas. You can still choose to e-file or mail your tax return to the IRS once you have it prepared, just as if you physically lived in the United States. In some cases, you will be taxed on the income that you earned throughout the world. However, you may be able to deduct a portion or all of the revenue that was not made in the United States in some circumstances. Filing Online The IRS offers an online filing option that is free for individuals that have an adjusted gross income below a specific threshold. Generally, your income must be below $66,000 to qualify for this service. You can also file online by using a commercial tax preparation software. Examples of this type of software include: H&R Block TurboTax TaxCut TaxSlayer There are many programs available that will file your taxes for you, often for a fee. Knowing how to file your own taxes can be a great way to save money, but it can be tricky as well. If you want to file your taxes yourself, be sure to read the form instructions thoroughly and get familiar with various tax saving opportunities before you begin preparing your return.
Setting Yourself up for Retirement
Whether you’re 21 or 60, it’s important to know whether you are saving enough for your retirement. There is no time like the present to ensure you are allocating enough funds for your retirement account. With folks routinely living into their 80s and 90s, it’s more important than ever to ensure your money lasts your lifetime.
Millennials have the advantage of having time on their side. They can benefit from compounding and the long-term trends that can make a real difference over the course of several decades. But it’s never too late to improve your savings plan and your retirement prospects.
In this article we’ll answer the question, “How much money do I need to retire?” and more.
When Do People Retire?
According to Gallup, the percentage of Americans who expect to retire at age 66 or older has risen dramatically, from 21% in 2002 to 41% in 2018. People expect to live and work longer than ever, so it’s never been more important to know when to stop working and how to carefully plan for the big event.
For persons born in 1960 or later, the Social Security full retirement age is 67. You will receive 70% of your monthly benefit if you retire at age 62, and 86.7% at age 65. However, you’ll get the maximum monthly benefit if you wait until age 70. These milestones might be an important consideration if your Social Security benefit will be a sizable portion of your retirement income.
How Much Do You Need to Retire?
Experts often say your target annual income after retirement should be about 80% of your pre-retirement figure. That is, if you were making $100,000 a year at retirement, you’d want annual income of $80,000 in retirement. Naturally, Social Security might not get you there, which means you must supplement your resources with a retirement savings plan. The sooner you start saving for retirement, the easier it will be to attain your target.
For example, if you require $80,000 a year and think Social Security will provide about half, your retirement plan will need to supply the remaining $40,000 (assuming you don’t work during retirement). If you expect to live for 25 years following retirement, you would need $1 million in savings if you didn’t earn any return on your savings. Luckily, you can expect a return that reduces your savings target. However, you must also contend with inflation, which will eat into the value of your savings.
If you earn 4.5% on your retirement savings and inflation is 2.5%, you’ll earn a real return of 2% each year. In our example, an annuity calculator puts your retirement savings goal at $796,557. Using a future value calculator, you can figure how much to sock away each year to hit your goal. For example, if you start investing $6,000 a year for 30 years and earn a 9% annual return (the long-term return on stocks since 1926 is 10%), you will have $817,845 at retirement, more than enough to meet the example target. You can use the calculator to figure out your annual savings goal based on your age and expected annual return.
If all that seems too complicated, try using the 4% rule. Simply divide your required annual payment by 4% to get your target savings amount. In this example, a required annual income of $40,000 divided by 4% gives you a target of $1 million. That’s a little higher than the calculator amount, which means you have more breathing room if you earn less than the expected average annual return.
Which Retirement Plan Is Best?
Generally, the best retirement plan is one in which your employer can make contributions, such as a 401(k) or 403(b). With these, you can contribute up to the annual limit and your employer can provide either matching funds or a non-matching amount. Your contributions are tax-deductible and not included in your taxable income — you pay taxes when you withdraw your money later.
In 2019, you can contribute up to $19,000 to your 401(k) ($25,000 if you are 50 or older). Your employer’s contributions are limited by the total contribution cap of $56,000 (or $62,000 if you are 50 or older). You must begin taking required minimum distributions (RMDs) by age 70, unless you are still employed. If so, you can continue to contribute and postpone RMDs until you retire. RMDs are based upon the account balance and your life expectancy, as estimated by the Internal Revenue Service.
If you are a business owner or self-employed, you can open a Solo 401(k) with similar limits. With these, you can’t postpone RMDs beyond age 70, even if you continue to work.
Another good alternative is an Individual Retirement Account (IRA). In 2019, you can contribute up to $6,000 a year ($7,000 if you are 50 or older). IRAs have tax-deduction and RMD rules similar to 401(k)s. You are allowed to have a 401(k) and an IRA at the same time, but the deductibility of your IRA contributions will begin to phase out if your modified adjust gross income (MAGI) exceeds a set amount. For 2019, the phase-out begins at $64,000 for single filers and $103,000 for joint filers.
Roth versions of IRAs and 401(k)s are available. These do not provide a tax deduction for contributions, but if you follow the rules, your withdrawals are tax-free. Roth accounts have no RMDs. Traditional and Roth accounts penalize withdrawals 10% before age 65 (for Roth, the penalty applies to withdrawn earnings, not contributions). They also offer some exemptions from the early-withdrawal penalty if you use the money for certain purposes.
Your retirement finances are not set in stone. You have options at any age. The important point is to understand how much you will need to live on and adjust your lifestyle accordingly. Naturally, the earlier you start saving for your retirement, the better off you’ll be. You can use online calculators to figure how much you’ll need to sock away to make your retirement comfortable.
Using a tax-sheltered retirement account makes saving easy, because you postpone taxes until you retire. Make a commitment to your retirement plan now and reap the rewards in your golden years.