Retirement and Tax Planning Strategies
The purpose of tax planning is to arrange your financial portfolio so as to reduce your taxes to the bare minimum. There are three basic ways to reduce your taxes. Reduce your income, increase your deductions and take advantage of tax credits.
Reducing your income
Your adjusted gross income is important. Begin your tax planning here. AGI is your income from all sources minus any adjustments to your income. The higher your total income, the higher your adjusted gross income. The more money you make, the more taxes you will pay. Conversely, the less money you make, the less taxes you will pay. The number one way to reduce taxes is to reduce your income. And the best way to reduce your income is to contribute money to a 401(k) or similar retirement plan at work. Your contribution reduces your wages, and lowers your tax bill.
You can also reduce your Adjusted Gross Income through various adjustments to income. Adjustments are deductions. You take them on page 1 of your 1040 and they reduce your Adjusted Gross Income. Adjustments include contributions to a traditional IRA, student loan interest paid, alimony paid and classroom related expenses. A full list of adjustments are found on Form 1040, page 1, lines 23 through 34.
The best way to reduce your taxes is to save for retirement, either through a 401(k) at work or through a traditional IRA plan. Contributions to these retirement plans will lower your taxable income and lower your taxes.
Increase your deductions and tax credits
Taxable income is another key element in your overall tax situation. Taxable income is what’s left over after you have reduced your AGI by your deductions and exemptions. Almost everyone can take a standard deduction and some people are able to itemize their deductions.
Itemized deductions include expenses for health care, state and local taxes, personal property taxes (such as car registration fees), mortgage interest, gifts to charity, job-related expenses, tax preparation fees and investment-related expenses. One key tax planning strategy is to keep track of your itemized expenses throughout the year. You should always take the higher of your standard deduction or your itemized deduction.
Your standard deduction and personal exemptions depends on your filing status and how many dependents you have. Your standard deduction and personal exemptions increase when you get married and have children.
The best strategies for reducing your taxable income is to itemize your deductions and the three biggest deductions are mortgage interest, state taxes and gifts to charity.
Maximize your tax credits
Tax credits reduce your tax. There are tax credits for college expenses, for saving for retirement and for adopting children.
The best tax credits are for adoption and college expenses. Not everyone is in a position to adopt a child but everyone could take some college classes. There are two education-related tax credits. The Hope Credit is for students in their first two years of college. The Lifetime Learning Credit is for anyone taking college classes. The classes do not have to be related to your career.
One of the best and most abused tax credit is the Earned Income Credit. (EIC) Unlike other tax credits, the EIC is credited to your account as a payment. And that means the EIC often results in a tax refund even if the total tax has been reduced to zero. You may be eligible to claim the earned income credit if you earn less than a certain amount.
Real Estate and Business Owners
A rental property owner for example may write off a percentage of travel expenses, office space and other business expenses. Business owners taxes are generally lower than payroll taxes. Consult with a tax adviser for the benefits of owning your own business and lowering your taxes.
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Make a plan and identify your goal
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Find quality employment
Savings and investments
Buy your first home
Buy adequate insurance
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