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.
Are You Planning for the Future?
Regardless of your career or experience with investing, odds are that you’ve at least heard mention of a 401(k). This tax-advantaged retirement plan is offered by many companies as a way for employees to plan for their futures and grow their savings.
But what exactly is a 401(k), how involved do you need to be in its management, and just how does it really work? Let’s take a look at this popular investment vehicle and see how it can completely transform your retirement planning.
What Is a 401(k)?
Named for the subsection of our country’s tax code that covers this type of account, a 401(k) is an investment account designed to save for one’s retirement. These accounts are offered by employers — meaning that you can’t open a 401(k) as an individual — and are designed to provide employees with a number of financial benefits while saving for their futures.
Your 401(k) account is tax-advantaged, which means it is designed to save you money on taxes that would otherwise be imposed on the funds. Depending on the type of plan you have, you will either realize these savings each year as you make deposits or once you are in retirement, when you go to withdraw the funds.
When you finally reach the end of your working career, you will be able to pull from this savings account — and the growth that it’s seen over the years — to fund your retirement.
How Does a 401(k) Work?
Let’s be honest: most people’s eyes glaze over when they begin reading their new employment offer and get to the section on retirement plans. After all, there’s plenty of confusing jargon in there, and you may have absolutely no clue what it all means.
When it comes to your workplace 401(k), though, the whats and hows are actually a lot simpler than they appear.
As we already mentioned, your 401(k) retirement plan is an investment fund established by your employer. When you are hired — assuming your workplace offers a 401(k) for employees — you will be asked whether or not you’d like to opt into this retirement savings vehicle.
Companies will typically give employees a handful of investment options for their savings, based on individual risk preferences. Most often, though, 401(k)s are invested in mutual funds, which make it easy to balance competitive returns with managed risk. Note that you may be automatically enrolled in a default investment option when you are first hired, though you can always change this to meet your preferences.
You can choose how much of your paycheck you would like to contribute to your 401(k), and your employer will automatically redirect those funds on your behalf. If you’re not very good at saving for retirement each month, this hands-off approach may be exactly what you need to prepare for the future.
Your money — and that of your colleagues — will be invested in the fund(s) offered to you, where your money will grow over time. Most workplace 401(k)s will automatically reinvest your earnings back into the investment fund, compounding your savings even more over time.
Regardless of how much your 401(k) earns in a given year, you will not need to claim the earnings on your income taxes. If you are stashing away pre-tax dollars — as is the case with a traditional 401(k) — you will pay taxes on your savings when it’s time to take distributions. However, this money will be classified as income rather than capital gains, saving you quite a bit of cash in the process.
Who Can Use a 401(k)?
A 401(k) is made available by many companies to their employees. Not all companies will offer 401(k) options, though, in which case you’ll need to put your retirement savings elsewhere.
A traditional 401(k) cannot be opened by an individual. If you do not work for a company that offers this retirement savings vehicle, you’ll instead need to opt for an individual retirement account, or IRA.
Why Is Your 401(k) Important for Retirement?
If you have the opportunity to contribute to a 401(k) while planning for retirement, you should take it! That’s because these useful accounts are incredible at growing your savings in a relatively safe, hands-off way. Plus, depending on your employer’s program, you might even get some free cash out of the deal.
The biggest benefit to a 401(k) is that it is tax-advantaged. This doesn’t mean you won’t pay taxes on your contributions or their growth, but it does mean that taxes are deferred and that you won’t pay capital gains tax on the gains earned in said account.
This can boost your current finances by lowering your annual income tax burden. It also gives you a way to bypass higher taxes on your investments’ growth. Plus, if you are in a higher tax bracket now than you will be at retirement, you’ll also save on marginal income taxes.
The next biggest reason you should absolutely invest in your 401(k) is your company match.
Now, not all companies offer a contribution match to their employees. If you are offered a match, though, you should take advantage of the opportunity down to the last cent.
A contribution match means that for every dollar you put into your 401(k), your employer will also contribute a dollar. There is usually an upper limit to this matching offer — for many, it’s somewhere around 3% of one’s annual salary.
Be sure you contribute at least enough each year to snag the maximum match offered to you. This means free money in your retirement account that you wouldn’t get elsewhere, just for investing in your own future.
Important Things to Remember About Your 401(k)
There are a few things to keep in mind about your traditional 401(k), both before you start saving and throughout the process.
You Can Continue Saving Elsewhere
Just because you’re saving in your 401(k) doesn’t mean that you need to have all of your eggs in one basket, so to speak. You can also contribute to an IRA, fund a high-yield savings account, establish a CD ladder, etc. Just be sure to max out your contributions (if possible) to take advantage of the tax and contribution matching available to you.
You Can Take It with You
If you change jobs, open your own company or just decide to take some time off, don’t fret: your 401(k) can come along. If moving to a new employer, you can usually roll your current savings into your new fund. If not, your options can include keeping your 401(k) where it is, cashing out or even rolling it into an IRA elsewhere.
Don’t Touch It Until Retirement.
Having a nice little nest egg in your 401(k) might be tempting, but be sure you don’t touch that money until it’s time to retire (according to the IRS, this is anytime after 59.5 years old). The penalty for pulling funds out early is steep: 10% of the distribution, plus the income tax you were already subject to on those funds.
Having a 401(k) offered to you by an employer is a fantastic benefit. It can not only help you successfully plan for your future, but is a great way to snag free cash and grow your savings along the way.
There are a few things to remember about your 401(k), like leaving the savings alone until 59.5 and earning the limit of your company’s match. By doing so, you’ll ensure that you truly maximize the benefits of this retirement savings vehicle.