Handling Finances

I know what you’re thinking — I promise not to mention politics in this post!  This isn’t about the government’s tax policies or broad economic theories.  This post is about how a little planning ahead can pay off significantly.

2007 was a year of transitions for me.  I finished a Masters program in optical engineering (laser physics) and I got a new job playing with lasers.  I got married and moved out into the scary real world.  I also started my first retirement accounts and started significantly saving for the future.  And that’s where my planning paid off.

Because I didn’t start working in my new job until the end of the summer and had only a low-paying research assistant position in the spring, I didn’t make a whole lot of money in 2007.  My wife’s nannying income certainly bumped it up but in the end, we earned just enough to start paying taxes.

My Tax Rate: 0.45%

I didn’t know exactly when tax rates would kick in, but I did know that my taxable income would be very low this year so when I started my retirement account, instead of putting 12-15% of my income into a tax-deferred 401(k), I maxed out my tax-free Roth IRA with after-tax money.  My effective tax rate for 2007 was 0.45% so assuming a 28% tax rate at retirement, I saved about $1100 in taxes — or at modest 6% return on investment, that’s 11-12 thousand dollars in retirement!

Why bring it up now?  Well, I was curious as to why I was only getting $600 in my rebate check.  There’s nothing I could have done (besides earning more) to get the full $1200 and to be fair, as a husband with a good-paying job, I wouldn’t be stimulating the economy with the extra money anyway.

The Plan for 2008

It’s a bit doubious to call low income a “tax break” but this type of year can be predicted ahead of time.  With a little planning, you can match your deductible donations with high income years (say, when you sell stock) and keep taxes as low as possible.

For 2008, I’m going to do much the same as with 2007 but for a different reason.  *warning — governmental tax-policy discussion ahead!*  With our government’s record deficit and much of the military action in Iraq funded only on an ongoing emergency basis (i.e. no budgeting for future expenses), taxes aren’t going to go down in the next decade no matter who runs the country (in my humble opinion of course).  With that in mind, I’ll continue to put as much money into my Roth IRA as possible.  Not only will I be trying to max out my Roth IRA contributions, but if I save more, I’ll be building up a reserve in my taxable account for future years.  I’m going to want as much money growing tax-free as I can get, and with tax increases on the horizon I’ll wait to put more than the minimum required to get a matching contribution until I can use that contribution to reduce my income when it’s taxed at a higher rate.

So I didn’t make it without mentioning the government and taxes, but at least I didn’t mention what I WANT to happen and which candidate I think would screw up the country the most…  Small victories I suppose.T

Yes, I know, it’s not technically “free” as it comes out of our taxes, but filing a tax return is a small price to pay for $300 or more. In the next few weeks, the IRS will be sending out letters telling taxpayers that you must file a 2007 tax return to get a stimulus rebate check.

While most of the 130 million Americans who qualify for the rebate check will be filing a tax return anyway, between 10 and 20 million are eligable to receive the rebate, but do not earn enough to be required to file taxes. The majority of those who qualify for the rebate checks but are not required to file taxes are Americans who receive social security or veteran’s benefits. This is considered income and can push citizens over the $3000 income limit. The key is that it must be included on a tax return or it won’t be counted toward the stimulus rebate checks.

If you filed a tax return but didn’t include social security or veteran’s benefits as income, be sure to amend your return to make sure you can qualify for the rebate check.

Filing taxes can be quite a hassle, and it’s very convenient to be able to skip filing when your earnings are low. This year, if you can claim income of $3000 or more, it’s worth the effort — file your return and qualify for your rebate check.

Check out the official IRS article for more information.