If you are eligible to but are not taking advantage of itemized deductions on your tax return, then you could be missing out on thousands of dollars in tax savings. Many people do itemize but are capped because they make too much money. And if you’re in this camp, maybe you’re wondering what you can do to shelter more money from taxes.
If you work for a company that has a 401k, 403b, or any other tax deferred retirement plan, then you should be contributing. There really is no better tax shelter than this, especially if you are in a very high tax bracket.
This advice may sound basic, but often times that is the best advice possible.
DON’T BE A HATER
As Taylor Swift says, “haters gonna hate, hate, hate, hate, hate”. But don’t be a hater of the stock market. Maybe you just don’t trust the stock market and that’s why you’re not contributing or only contributing a very small amount. Besides you can invest into more than just stocks within your 401k.
Don’t dismiss the stock market outright. Yes it can be volatile but it can also provide you with very nice returns over time. Notice that I said “over time”. Unfoturnately we live in a “give it to me now” society, so many do not exercise the patience that is required with the stock market.
The media would have you believe that the stock market is like going to a casino. Why would they do this? Because fear sells. Based on this, you would think the stock market goes down every year. But did you know that the stock market on average goes down 27% of the time, which means that it alos goes up 73% of the time. Those odds are much better than the casino.
You may think that you can’t afford to save to a 401k. I would argue that you “can’t afford not to”. Take this simple example. Assume that you save only $100 / month, which equates to $1,200 / year. If you are in the 25% federal tax bracket, you just saved $300 in taxes. So in reality, you are saving $1,500 / year ($1,200 + $300).
If you invest $1,500 / year for 20 years earning 7% per year you will end up with around $60,000 even though you only contributed $30,000.
If you can get past the negative perception of the stock market, then you will likely find that a 401k provides a very nice tax shelter. Consider that if you are under the age of 50, you can save as much as $18,000 per year to a 401k. Over age 50, and you can save a whopping $24,000 per year. That translates to a tax savings of $8,400 per year if you’re in the 35% federal tax bracket.
I’ve been a financial planner long enough to know that not everyone can save that amount of money. But don’t let that stop you. Just start somewhere. Consider that if are able to start saving early enough, then you can amass a very large amount of money even if you don’t make a lot of money.
For example, assume you decide to save $100 per month when you are age 20. If you do this for 40 years, you will have contributed $48,000, but your investment would be worth $264,000 if you earn a 7% rate of return. Obviously, the more you save the more your investment will be worth.
Whether you’re in a high tax bracket or a low one, contributing to a company retirement plan will likely be your Ultimate Tax Shelter.