I'm pretty sure no one likes paying taxes. With the start of the new year, and tax season approaching, I thought it timely to share a few simple tools that help me pay less in taxes and save more. While basic, these are things I had to learn on my own. Most of this will only apply to U.S. readers.
Planning ahead
I took some time over the long weekend to plan ahead for 2017. Those of you that have been following my story know that in 2016 I had some unexpected medical expenses. While I don't necessarily have a set budget, each month I do track all of my spending. I break down all of my expenses into basic categories such as travel and eating out. I use this to plan for the future and highly recommend tracking your spending for a couple of months. I get a real eye-opening perspective of where my money is going at the end of each month.
This also has helped me predict what my expenses will be in 2017. I know my medical and travel expenses will still be high as I travel back home for additional tests and doctor visits. I am also saving up for a few small trips later in the year when my health (and the weather) is better. Right now I am looking at taking a trip to Seattle this spring. I have never been to the Pacific Northwest and am excited to do some light camping and hiking. If you are familiar with the area, let me know in the comments!
Anyways, enough about me. Here are the basic tools that I use to reduce my taxes and save money:
401(k)
If you work for a traditional large company, like I do, you'll probably have access to a 401(k) savings plan. Non-profit employees have something similar called a 403(b) and government employees get a 457(b). These plans allow you to have money taken out of your paycheck and saved for retirement. Any money deposited in this account (up to $18,000 a year) will not be taxed. The best part is that some companies will match a certain amount of the money you put in each year. That's free money just for participating! Unfortunately, each company has a different plan so the exact details will be different and not everyone has access to one of these plans. Also, the money in these accounts is meant for retirement, so it can be a little difficult to withdraw early if you need it.
IRA
Individual retirement accounts (IRAs) function very similar to a 401(k). Up to $5500 a year can be taken out of your paycheck tax free. The benefit is that IRAs are not tied to an employer. Anyone can open an IRA and start saving. Another advantage is that contributions through April to an IRA can be used to reduce last years tax bill. That means that even though it is 2017, you can still use an IRA to reduce taxes from 2016.
HSA
A health savings account (HSA) was quite important for me last year. An HSA allows you to save money for healthcare expenses and not pay taxes on it. Anyone with a "high-deductible" insurance plan can use an HSA to save money tax-free. Many of the insurance plans available through the affordable care act qualify for HSAs. The great thing about HSA's is that they never expire. If I didn't use all the money in my health savings account, I can keep it for next year. This is the major difference between HSA's and flexible spending accounts (FSA's). With expected changes coming to the affordable care act, health savings accounts may change. For now though, HSA's are a great way to plan ahead for medical expenses.
Good points, thanks for sharing. Other things to consider to lower your tax bill are to buy a home instead of rent to get the mortgage interest deduction, and work as a 1099 contractor instead of employee if possible and it makes sense for your situation so that you can write off expenses against your income as a business.
I'm sure there are other good ideas, as well, but I'm no tax accountant...
Good points. Further into my career I would like to move into consulting from regular engineering work. Tax benefits would be a plus!
Like many milllenials, I don't think home ownership is in the cards for me. Home prices are actually affordable in my rust belt town, but I value the career flexibility that renting allows.
1099 is a great transition if you can swing it, both from the perspective of finding work and being able to weather potential increase in volatility of earnings. The benefit of the employment relationship is generally income smoothing, but if you can tolerate additional risk (after perhaps building savings cushion), then the tax benefits and greater take in total compensation are worthwhile. I was at that stage in my previous career, but stepped away for academia...once done with this i'd prefer either being an entrepreneur and/or 1099 contractor.