Whenever you start reading a financial article, usually you find that the first point is to save a significant amount every month. Undoubtedly it’s the first step. But saving only can’t make your money grow. For that, you need to invest. Saving is putting money aside so that you can use it during an emergency. On the other hand, when you invest, you buy stocks, mutual funds, bonds, real estate with the expectation of getting a better return in the future.
Financial advisors also say that you should start planning for retirement and a better financial future from the day you earn your first paycheck. However, the young earners also look for tax saving strategies since the income is comparatively low during this time.
Let’s check out some tax-saving investment tips for the young earners.
Invest in a tax-qualified retirement account
The financial advisers always say that you should start contributing to a retirement account from the beginning of your financial living, this means the first income you get from your work. Usually, investing a smaller amount for a longer period is more effective than investing a larger amount for a shorter period. If you start early, your spare cash can help you save a big amount at retirement and it has tax advantages too.
So, first of all, start contributing to a 401(k) account. Take full advantage of the compound interest and maximize your contribution if your employer is providing an exact match. “A 401(k) is a retirement savings plan sponsored by an employer in America. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account”.
The amount you contribute to 401(k), you can deduct this from your taxable income in the year you contribute.
By opening a Roth IRA (an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement under United States law), you won’t get any deduction at present, when you’re a young earner and have just started your job life. However, if you have a long term vision, you can opt for this. While withdrawing your amount at or after 59 and ½ years of age, you won’t have to pay any tax.
And, when you’re over 50, you can make additional tax-deductible catch-up contributions to your Roth IRA.
However, this type of investment is not without any disadvantages. First of all, you can’t contribute whatever you feel like. There is a limit as per your household income and it is capped at $6,000 in 2019 and 2020. And, this is the maximum limit combining your Roth as well as traditional IRA.
Choose accurate account type for your investments
You will have to decide where you would like to hold your securities. You have two options as a young investor.
You choose investments that limit tax burden like exchange-traded funds, tax-managed mutual funds, individual securities, etc. These are more suitable for taxable accounts.
Certain investments generate taxable income. These are taxable bonds and stock funds with high profit. It is better to keep such investments in tax-deferred accounts like traditional IRAs or other retirement accounts. This will help you defer applicable taxes on your profit. Doing so, you won’t have to pay taxes right now and you can delay paying it.
When we are talking about investments and tax savings, this can be a good move. It is a bit difficult to find spare cash in your early career. But, there’s a way to find additional money.
Calculate how much amount you’re expecting as a refund. That means, the amount of taxes held back from your paycheck. So, you can reduce your withholding and increase your paycheck amount. But, make sure you set up an automatic deposit to any of your investment accounts so that you can save the amount.
Moreover, whenever you get any bonus or your salary increases consider increasing your investment amount or open a new investment with tax-saving facilities.
Pick up a high-deductible health savings account
As per financial advisors, as a young earner, picking up such an account is a smart move. Not only the premium of a high-deductible plan is relatively less expensive, but also has several other advantages.
The contributions you make to your HSA (Health Savings Account) is usually with pre-tax money. It is made through payroll deductions which your employer makes. Therefore, the amount is not included in your gross income and so, you don’t have to pay any federal tax on the deposited amount. In most states, you don’t have to pay any state income tax too.
However, if your contributions to HSA is with after-tax money, then you can deduct the amount from your gross income while preparing your tax return. Thus, your tax bill will be reduced.
Another advantage of having an HSA is that you can withdraw an amount from this account for qualified medical expenses without having to pay any tax.
Whatever you earn in this account, that is the interest and dividends, is also tax-free. And, the interest you earn on the deposited amount is also tax-free.
However, if you withdraw funds from your HSA before 65 for non-qualified expenses, then you’ll have to pay tax on the withdrawn amount along with a 20% penalty.
Another question can come to your mind that what happens to the amount if you change your health insurance plan in America? Well, in this case, you can use the money for future qualified medical expenses.
So, don’t delay in making your decisions. Start early, take advantage of tax-efficient investments, and lead a stress-free, happy life with a secure financial future.
Good Nelly loves to analyze the day-to-day financial happenings along with critically analyzing the changing rules of credit, debt, insurance, mortgage, etc. related matters. She loves to share her analysis with others thus helping people to understand the exact scenario.She also maintains a blog My Way Of Viewing where she writes about her experiences.