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THE FEDERAL TAX CODE now contains over 10 million words, so it’s no surprise that most Americans score an “F” when it comes to understanding taxes. A few years ago, I would also have flunked.
But following my divorce, I knew I needed to educate myself on financial topics. While I could tell you how much I took home each month, I didn’t have a clue how much I paid in taxes, much less what my marginal tax rate was. While I’m still not a tax expert, I have become familiar with the basics of tax-deferred savings, and I’ve used that knowledge to increase my retirement account balances, while decreasing the amount I pay in taxes.
I started out learning about the different IRAs available and the tax advantages of each. I’d be eligible to deduct any contributions I made to a traditional IRA, but I’ve chosen to invest in a Roth IRA instead. Anybody with earned income can contribute to a Roth, as long as they fall below the income cutoff. While the contributions I make to my Roth aren’t tax deductible, the earnings—when I draw them out in retirement—won’t be taxed.
Next, I began to look at ways to reduce my tax liability. I discovered that if I contributed $18,000 a year to my 403(b) account, I could keep my marginal tax rate at 15%. By using Financial Finesse’s online calculator, I found that maxing out my 403(b) resulted in annual tax savings of $4,500. That means the $18,000 I’m investing each year is effectively costing me just $13,500.
Recently, while exploring the IRS website, I learned I’m among the 70% of Americans who are eligible to file their taxes electronically for free. This benefit alone will save me more than $70 in fees.
By understanding, and taking advantage, of just a few basic tax strategies, I’ve been able to significantly reduce my personal income tax burden. Paying less in taxes means having more money to spend on other activities—activities I find more fulfilling than filing a tax return.
Kristine Hayes’s previous article was From Half to Whole. Kristine is a departmental manager at a small, liberal arts college in Portland, Ore. She enjoys competitive pistol shooting and hanging out with her dog Zoey.
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