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.
Building Your Savings
Succeeding at personal finance is less about the physical steps to get there and more about why you’re saving. In other words, it’s a mental problem, not a physical problem.
Let me explain. Making smart choices, spending less or saving up money are pointless without a reason why. Working toward a specific goal will always be more motivating than saving up because it’s one of those things you “should” do. These days, financial independence is a common goal, with many people willing to create a big savings rate in exchange for being able to retire a couple of decades before the usual age.
Others don’t want to wait nearly that long. These folks are saving for various short- to medium-term goals. Maybe they want a new car. Perhaps they have a dream trip in mind. Or maybe they’ve always dreamed of place they can truly call their own, and are focusing on saving a down payment.
It doesn’t matter what the goal is. It can be as serious or frivolous as you’d want. All that matters is the goal is important to you. It needs to motivate you when life gets a little tough.
Most money goals aren’t easy. But the result is worth it. There’s no better feeling than knowing you’ve saved up for something and paid for it using your own money. And like with any goal, extra-difficult money ambitions feel extra good when you pull them off.
We’ve built a savings calculator that can help make all your monetary dreams come true. Let’s take a closer look at how it works.
This calculator will show you the wonders of consistent saving. Here are the various parts of the form you’ll have to fill out:
This is the easy one. This is exactly how much money you’re starting out with. It can be as little as $1 if you haven’t started saving. Starting out with more will make the ultimate goal much easier, but don’t sweat it. What you do going forward is going to determine your savings path.
This is how much you can expect to save each month. The more you can save, the better.
A word of caution before you fill out this amount. Many non-savers will find a calculator like this and suddenly proclaim themselves as frugal champions, able to put away $1,000 per month or even more. Don’t fall into that trap, or you’ll find yourself deprived in no time. Pick an achievable savings goal for best long-term success.
Perhaps gradually working toward your savings goal is best. A few months of feeling deprived is a formula for failure. It’s exactly why crash diets don’t work.
Simply put, this is the rate of return you can expect from your investment.
Different investments will deliver vastly different rates of long-term returns. Remember, risk and potential reward are related. An investment with a great deal of risk has the potential to be more profitable than a safer one. Just remember that a risky investment could easily lose money, too.
For example, a savings account at a bank is guaranteed by the federal government, up to a maximum of $250,000 per depositor per institution. Since the principal is 100% guaranteed, these accounts don’t give much interest. Investors who put their cash in a savings account are more worried about keeping that money safe versus earning much on it.
High-yield savings accounts are offered by certain banks as an attempt to lure depositors to that particular company. These are typically offered by online banks that don’t have any physical branches, which is a big downfall for some folks. These accounts offer much better rates than regular savings accounts, usually in the 2-3% range. They also come with the same principal guarantee, meaning you’ll never need to worry about the security of your bank. The cash will be there.
Many people will keep their emergency fund in a high-yield savings account, a nice compromise that allows them to earn a little interest off their money while keeping it easily accessible.
Another relatively safe investment choice is bonds, which are instruments used by governments or companies to borrow money. These are secured either by specific assets or, more commonly, the general credit-worthiness of the issuer. The yield depends on the security of the issuer. An ultra-safe bond will pay around the same as a high-yield savings account, while riskier ones will offer 6-8% returns.
Real estate and stocks offer the best potential returns, but both come with a great deal of risk. Both of these asset classes tend to offer approximately 8-10% total returns annually over the long-term, but with individual years fluctuating wildly. For instance, in 2013, the S&P 500 delivered a 29.60% return. Yet just a few years before that, in 2008, that same index fell more than 38%.
These kinds of volatile returns are fine if you’re willing to hang on during downturns. The stock market will inevitably go up over time. Short-term concerns eventually become nothing but a distant memory. Just make sure to hang on and not sell at the bottom of a correction. If anything, that’s the time to buy.
Real estate itself tends to move a little less than stocks, but the asset class still has risks. A landlord renting out a house has many different threats that could cause the investment to temporarily perform badly. A tenant might move out and slow economic times mean there are few replacements looking for a new place. Or the property can be damaged, either by a natural disaster or a disgruntled renter. All of these things can temporarily depress returns, which is made all the more risky by borrowed money.
Number of Years
Another simple category. Just input how many years you plan to save.
I’d encourage savers to play around with this category to see the impact of compounding over time. It’s amazing how large your savings can become over a few decades, especially if you’re getting 8-10% long-term returns. Financial independence may be closer than you think.
How to Increase Your Savings
It takes a long time to save up for an expensive goal if you’re just putting $100 or $200 per month away. Here are some easy ways you can dramatically increase the amount you’re able to save.
The most important thing to remember is that there are three main expenses, costs that will usually eat up at least half of your budget. If you can get your housing, transportation and food expenditures down, that’ll immediately help increase your savings rate in a big way.
Let’s start with housing. If you’re comfortably saving money each month, then it’s okay to spend a little extra on a nice place or one with extra room. If you’re struggling to get ahead, it’s time to slash this expense. You’ll either want to move to a cheaper part of town — closer to work, ideally — or get a roommate to help offset some costs. Yes, this is a sacrifice, but you’ll free up hundreds of dollars each month.
Transportation is another big one. Moving closer to work is a great option, since that’ll cut down on transport costs and free up time. You’ll also want to explore public transport. If your city doesn’t offer acceptable bus or train schedules, look at splitting commuting costs with a coworker. You’ll both save money and have company for the long ride to work.
Food is usually an easy category to slash. The solution is simply cutting back on restaurant meals and eating more at home. Drinks are also a budget killer; it’s easy to spend $100 on a nice meal out with a few drinks. You can cut that by 80-90% by making your own meals and enjoying drinks at home. If drinking alone doesn’t appeal to you, feel free to invite your friends over.
Cutting back on groceries isn’t hard, either. The key is to plan your meals around sales — especially those on the front of the flyer — rather than planning your meals and then buying whatever you feel like.
Buy Less Stuff
Aside from these three categories, another simple way to cut back on expenses is to buy less stuff. Before putting new clothes or some upgraded electronic device in your cart, ask yourself if you really need it. If the answer is no, delay the purchase for a while.
Experts agree that a 10% savings rate is the minimum you should strive for.
Taxable versus Non-Taxable Accounts
Where you save your money matters. Some accounts offer the ability to shield taxes, while others will force you to report any profits to the IRS.
A taxable account is one without any special tax privileges. You’ll be forced to pay the tax man his share on any of your gains each year. Note that you’ll have to pay taxes on both earned income from the investment (like interest or dividends) as well as on any capital gains when a profitable investment is sold. The good news is that capital gains are taxed at a favorable rate, something the feds put in to encourage investment in the stock market.
As a general rule, any long-term saving — like for retirement — should be done in tax-sheltered accounts. You’d use a taxable account for any short-term goals, remembering that you don’t want to take major risks with money you’ll need right away. This cash is usually kept in savings accounts.
There are two main retirement accounts you’ll use for long-term saving: Roth IRAs and 401Ks.
Let’s start with a Roth IRA, which is a retirement account that is funded using after-tax dollars. Any amount put into a Roth can be withdrawn without a tax penalty, but the earnings on those contributions do carry a withdrawal penalty if you’re under the age of 59.5. You’ll also have to wait until your Roth account is at least five years old before you can withdraw any earnings without penalty.
A Roth IRA offers nice flexibility. You’ll just have to be a little bit careful making sure you follow the rules.
Roth IRAs are limited to a $6,000 annual contribution, and some high-income earners make too much to be eligible for the savings account. The limit for single folks is just over $120,000 per year, with the maximum for couples at just under $200,000 per year. These folks can still contribute to different kinds of IRAs, but they’re shut out of Roth IRAs.
The other main tax-deferred savings account Americans will use is their 401K, an account that is funded by pre-tax dollars. Employer-sponsored 401Ks are common, with some employers contributing 5% (or more) of their worker’s salary as a 401K match.
Savers also get an immediate tax break when they contribute to their 401K account. Here’s how it works. If you make $70,000 and contribute $5,000 to your 401K, the government will tax you like you made $65,000. This usually translates into a tax refund, which is always a nice bonus. This tax refund can then be immediately reinvested — like into a Roth IRA — to really help give your savings a boost.
There’s just one catch. You’ll have to pay taxes on 401Ks when you withdraw the cash. The strategy works best when you contribute during high tax years and take cash out slowly during low tax years. A little planning during your golden years can really help bring the overall tax bill down.
The Bottom Line
Having the desire to save up for a big purchase is great. Most people wouldn’t save without this motivation. It doesn’t matter what you’re saving up for, as long as it’s important to you. It can be as frivolous as you desire.
But dreaming can only get you so far. At some point you’ll have to execute your vision. That’s where this calculator really shines. It shows you just how much you’ll need to put away every month to follow your dreams. Some of you might use the calculator and realize you’re right on track to accomplish your goals. Others might need it to provide a much needed kick in the pants.
Go ahead and live your life. Just pay for it first. A life wallowing in debt isn’t a lot of fun.