Everyone has heard the saying that nothing is certain except for death and taxes. Both of these are scary things for people. However, by learning a little about taxes, you can make smart decisions to ensure you understand how you can optimize your resources.
In the US we have what’s called a “Progressive Tax” system on earned income. This means that every wage earner falls into a tax bracket where higher earners are charged a higher percentage than lower earners. An individual making $9,000 would fall into the 10 percent tax bracket, while a couple making $200,000 would fall into the 24 percent married tax bracket.
Within the progressive tax system, there is an additional breakdown between effective and marginal tax rates. The individual in the lowest (10 percent) bracket pays straight up 10 percent. Individuals in the next tax bracket pay 10 percent on the first $9,525 they make (for single income), then 12 percent on everything above that up to the next tax bracket, etc. The couple earning $200,000 only pays 24 percent on everything they make above the last tax bracket.
Re-read that last part again if you need to, but here is a helpful visual!
When you understand what how taxes are charged, you can learn how to optimize for them. For example, if you save a portion of your money into a pre-tax 401(k) or IRA, you might be able to drop your taxable income into a lower tax bracket! This can save you money now and allow your funds to grow for your future—win!
In addition to income taxes, there are many other types of taxes that you will want to be aware of. Many states and even some cities charge taxes on residents. If you own a home or land, you will probably pay property taxes. If you live in an area that is being developed or has a new attraction (such as a stadium!), you will likely see high taxes charged in local restaurants.
These location taxes are not something we typically think about when choosing where to live. However, if you are looking into purchasing a home, moving to a new city, or renting in a new area, it is a good idea to understand what taxes could affect your cost of living there. Living just a few miles in a different direction could potentially save you significantly in the long run!
If you have traveled recently, you might have noticed the substantial taxes you were charged at the hotel you stayed at. These could vary if you stay in one state or city compared to the next. And if you drank alcohol or used tobacco or marijuana products, you likely saw what is called a “sin tax” on your purchase.
Although many people may not have an estate worth $11 million, it is also good to be aware that estates above this value will also be taxed. Those with significant net worth will want to work with a financial advisor to ensure their estate is optimized for taxes so they can pass down what they would like to their beneficiaries and heirs.
Taxes aren’t fun, but they do have a reason in our society. Some people may debate their virtue, but the facts are that current laws dictate we pay taxes. Once you understand them they don’t have to be scary!
With a little attentiveness, you can understand your current tax burden and work to optimize your future choices to ensure you are making the best tax decisions for your financial future. Your financial advisor is ready to help you with any question along the way!