A Dollar Saved is Two Dollars Earned
Cutting your expenses is a big deal because most of your personal saving is done using after-tax dollars instead of before-tax dollars. For many American households, to increase their wealth through higher investment returns or more income by $1 could require as much as $2 of pre-tax income. If this is achieved through investing, this requires that you put more savings at risk to attain these returns. If it is achieved through working more hours or taking on a second job, it can be very stressful. Sometimes thinking about your spending and saving money can be much less painful than the risk of loss through investments or the toil of taking on more work.
Let’s consider our hypothetical fellow named Jim. Jim is a car salesman in Los Angeles, California. After deductions, his income is $87,000 this year, his best year yet by far!
Since he makes that much, he’s in the 28% income tax bracket for federal taxes, and California takes an additional 8% cut. Beyond that, payroll taxes take up 4.2% of his income. Since there’s also an additional sales tax of 8.75%, out of every $100 Jim earns he can actually only spend $51.05.
So every time Jim wants to have access to an amount of money in the $50 range, he has to ask himself whether he would rather work on getting $100 in additional commissions or simply save the amount he wants. Ultimately, a balance of the two will provide Jim with both the immediate money he needs through working in the short term and the long-term wealth he will eventually need by refining his habits and investing his income.
However, Jim can choose exactly what his preferred balance may be based on how he wants to live his life and whether he believes that working or saving is more of a hassle.
Ultimately, Jim’s situation is a lot like many people’s. For some people, it is easy to slash their spending in almost every area. Some people really do have extremely simple tastes in life. But for other people, working more is no big deal and saving feels like a huge burden on them. For natural savers, the big earners look like they’re working hard, but for the earn to spend crowd the idea of saving carefully seems like an exotic form of torture.
Tax Planning
For most households, taxes are the biggest expense. Paying taxes is inevitable, and it is a very bad idea to practice tax evasion. Even the gangster Al Capone couldn’t get away with it. Fortunately, tax planning and tax avoidance are perfectly legal. You should see a tax professional find out every way you can save on taxes, but there are a few areas where just about everyone can find some relief.
For example, most municipalities that have property taxes (and there are not many that don’t) also tend to have some kind of homestead exemption. While a homestead exemption is a great way to keep down your property taxes, you can also lower them by having your home’s official value reassessed. Don’t worry about lowering the amount of money you may be able to sell your home for down the line, as the officially assessed value is not the same as the salable value that a real estate agent would declare that your home is worth.
In most cases, your assessed value does nothing more than determining your tax rate. So starting the often long process of having this value reduced is a good use of your time.
Can You Deduct Losses?
Harvest losses from your investments so that you can deduct up to $3,000 in net losses from your taxable regular income. This is a very, very neat trick that allows you to match investment losses to your regular earned income. For most people, this is a great deal because their highest tax bracket is higher than long-term capital gains.
You may be able to deduct many expenses associated with your job. Whether you need a uniform, a good suit, a dedicated cell phone, or a pair of gloves, you should see if you can deduct everything that you can in order to reduce your income taxes.
Other tax areas where you can save may involve the payment of mortgage interest and the contributions that you may be made to a tax-advantaged account (you can’t deduct contributions to Roth accounts). You can even potentially set up a health savings account that can keep money both in case you need it for a medical emergency and so that you can reduce your taxable income by the amount of your annual contribution to the account. Naturally, setting up these kinds of accounts can save you a ton of money on your taxes.
Be sure to record and deduct charitable contributions you make. Donations to religious institutions are almost always deductible from your taxable income.
Tips
If you want to make the most out of your money and learn how to channel it to the right places in order to maximize your taxes than you must read this great article on The Importance Of Accounting.
