Tax Considerations for Millennials
Are you someone who waits until the last minute to file your taxes? Well, I’m going to reward your bad behavior with some tips that are (almost) as delicious as a late-night pint of Ben & Jerry’s.
While the tax code doesn’t discriminate (much) based on age, there are a few pieces of the code that I would like to put into context for my fellow Millennials so that you can achieve some greater peace of mind when you sit down to stress about your taxes.
Keep in mind: I am not a tax professional. No one here at Generation Capital Management gives tax advice. But I can help you to understand a few tricks that might just help you keep more of your hard-earned cash.
Beat the system
Here’s a fun little trick: make the same amount of money but pay less in taxes.
To put it very simply, how much tax you pay is based on how much money you make. The technical term is “taxable income”. In general, the higher your taxable income, the more you can expect to pay in taxes.
It should follow, then, that we can lower the amount of tax we pay if we can lower our taxable income. And there’s a way to make the same amount of money while decreasing your taxable income.
Contributions to your employer-sponsored retirement plans can do exactly that. And if you don’t make too much money, contributions to traditional IRAs do the same thing. This means that you get to give the government less of your money just by moving some money from your bank account into a traditional IRA.
Why is that important? Well, you can make a prior-year contribution to a traditional IRA until the tax filing deadline for that tax year. So, if you put together your taxes and see that you need to pay the government $1,000, try putting into the tax planning software that you make a $1,000 traditional IRA contribution instead. It would probably reduce how much you owe in taxes.
Lower income this year? Make it count!
A lot of us Millennials are at the stage in our lives where we have a tumultuous relationship with work. We might take leave to introduce new children into our families, separate from work to explore a different opportunity, or maybe even need to take some time off to go back to school.
As much as it can be a challenge to not have regular income, we have an opportunity when it comes to our taxes: Roth contributions (or maybe even Roth conversions)!
A ‘traditional’ contribution is done on a pre-tax basis, and then tax is taken on money that you withdraw from the account in the future. For a Roth contribution, we use after-tax dollars. We don’t receive a tax deduction for these contributions (so they won’t lower our tax liability) but we don’t pay tax on the money we take out of Roth accounts later on.
If you’re following me, you might see where I’m going. If we’re in a low tax bracket this year because we had lower taxable income than usual, it might make sense to make a Roth IRA contribution at tax time instead of a traditional IRA contribution that would lower your taxes.
The reasoning for this is very technical and would make your eyes glaze over. If you have questions about this, email me at jhowe@gencapmgmt.com and we can walk through it together.
Tax form panic
A lot of us have been changing jobs lately, and that means we’re moving our old employer-sponsored retirement plan balances into new employer-sponsored plans or an IRAs.
If you did this, you probably received a tax from (1099-R) from the investment company that held your assets in the old plan. You might have even panicked to see that the form didn’t say anything about that distribution being tax free.
Don’t panic, this is very normal.
As long as you moved the money into a qualified account (like another employer-sponsored plan or IRA, depending on your situation), you’ll be okay. You should receive another tax form from the investment company that manages the new account AFTER the tax filing deadline. This form will say that you deposited that money into an account with the new investment company.
If you don’t receive a copy of this form, reach out to the new investment company and ask if they can send you one. You’ll want to keep that with your tax documents for that filing year.
The only thing student loan interest is good for
According to a study by the Harvard Kennedy School Institute of Politics, 42% of Millennials report that they or someone in their household are servicing student debt.
This isn’t surprising. With the rapid rise in costs of higher education and the fact that many of us were heading to college during the ’08-09 financial crisis, taking on student loans was the only way that a lot of us could afford to attend school.
The federal student loan repayment pause resulting from the COVID-19 crisis has meant that no one with federal student loans needed to make payments on those loans. But those of us with private loans have been required to continue making payments.
The good news is that if you’re making a payment on any student loans (federal or private) and a portion of your payment is going towards interest, then you may be able to deduct the interest that you’re paying to offset your tax liability. Certain income and deduction maximums apply. But it’s definitely worth making sure that your student loan interest payments are being considered in your tax calculation.
Mortgage interest: blessing or curse? Yes.
Tons of us are looking to buy our first home or move from one home to another. Anyone planning to use a mortgage for this knows one thing: interest rates on mortgages are absurd right now compared to where they were even a year or two ago.
It would obviously be better if interest rates were lower. The good news, though, is that you can deduct your mortgage interest on your taxes. There’s a little bit of a technical caveat here: you can only use this deduction if you “itemize” your deductions.
I don’t want to get in the weeds on this, but the basic point is that you can either take the standard deduction or you can itemize your deductions. You typically choose whichever of those two options gives you the lower tax liability.
As the amount of interest you pay on your mortgage increases, it becomes more likely that itemizing makes more sense.
HSA (use it to pay for therapy)
Most Millennials started working in the late “aughts” (2000s) to the early 2010s. This was an interesting time in the health insurance industry as companies started moving away from plans that covered more of a worker’s healthcare to high-deductible health plans (HDHPs) which offered lower premiums being taken from the employee’s paycheck but more out-of-pocket costs for the employee.
I don’t want to make a quality statement about the shift to these types of plans. But there is a really nice feature that comes along with them: access to a health savings account or HSA. You can’t contribute to an HSA unless you’re enrolled in a high-deductible health plan.
HSAs are a great vehicle. They allow you to make contributions before tax, you keep the funds that you contribute to an HSA even if you don’t use them that year, and then the distributions are always tax-free as long as they are used for qualified medical expenses.
The best part: contributions to an HSA reduce your taxable income just like pre-tax contributions to an IRA. The result is that they can save you money on your taxes.
You can make contributions to an HSA for a tax year until the tax filing deadline for that year. So, if you fill out your taxes and it looks like you owe, try seeing how your tax liability changes if you put that money into an HSA instead.
This is a bit advanced, but HSA contributions may be even more useful than IRA contributions for reducing tax liability because there are no maximum income limits for deducting HSA contributions. Whereas with IRAs, you can’t claim a full deduction from your taxable income for contributions if you make above a certain amount.
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None of what I talked about here is super straightforward, so don’t hesitate to reach out to me if you have any questions. Like I said above, you can email me directly at jhowe@gencapmgmt.com or click here to set up a free consultation!
John Howe-Wemett, CFP®, M.S.
