Today, I have three excellent questions about reducing taxes and saving money.
Kari says, “Love your podcast! Can you clarify whether investing in a Roth IRA and I bonds helps your taxes by reducing your taxable income–or are pre-tax retirement assets, such as a 401k, the only way to bring your taxable income down?
Jennie says, “I love your podcast. My fiance and I both qualify to contribute to our Roth IRAs. Once we get married, can we still contribute to them if we file taxes separately, or do we have to file jointly?”
Lisa, F. from Houston, Texas, says, “Love, love, love your podcasts! Thanks so much for being a wonderful, informative resource for everyone, but especially for women! I’m about to be a retired school teacher and must stretch my pennies. Once I spend all my flexible spending account (FSA) funds, what medical expenses can I deduct on my tax return?”
Thanks for your question, Kari, Jennie, and Lisa! I’ll answer them so you have more clarity on terrific ways to reduce your taxes and keep more of your hard-earned money.
Which investments help reduce your taxes?
At the heart of Kari’s question, she’s asking which investments or accounts help reduce your taxes. So, let’s review how several tax-advantaged accounts work to cut your tax liability.
Contributions to traditional retirement accounts, like a traditional 401(k), 403(b), or IRA, are made on a pre-tax basis and reduce your taxable income in the current year. For instance, if you earn $60,000 and contribute $7,000 to a traditional IRA, it reduces your taxable income to $53,000.
However, suppose you or a spouse contribute to a traditional workplace retirement plan and a traditional IRA in the same year. In that case, some or all of your IRA contributions may not be tax-deductible, depending on your income.
Laura reviews six rules you should know to take advantage of multiple retirement accounts and avoid pitfalls. Listen to that episode in the player below.
With a traditional retirement account, your contributions and investment earnings get taxed as ordinary income when you take withdrawals. Making withdrawals before 59.5 means you’re subject to income tax plus an additional 10% penalty.
So, you don’t escape taxes with a traditional retirement account but defer them to a later date. You must take annual required minimum distributions from traditional retirement accounts starting at age 72 or 73, based on your life expectancy and account balance.
The other primary type of tax-advantaged retirement account is a Roth. With a Roth 401(k), 403(b), or IRA, your contributions are made on an after-tax basis, which means they are nondeductible. For instance, if you earn $60,000 and contribute $7,000 to a Roth IRA, your taxable income is $60,000.
While Roth contributions don’t reduce your taxable income, their investment growth is never taxed after age 59.5. That means your Roth withdrawals are entirely tax-free–plus, they have no required minimum distributions. Skipping taxes on Roth investment earnings could save you a bundle! However, the Roth IRA has an annual income limit, which I’ll review in a moment.
However, like a traditional account, early withdrawals of untaxed earnings from a Roth before 59.5 would be subject to income tax plus a 10% penalty. But your original contributions can be withdrawn tax and penalty-free from a Roth IRA at any time.
In addition to retirement accounts, other tax-advantaged accounts reduce your taxes.
For example, contributions to a health savings account (HSA) are tax-deductible, reducing taxes. Withdrawals from an HSA to pay qualified medical expenses are tax-free.
However, you must be enrolled in an HSA-eligible health plan to contribute to an HSA. You could purchase the policy through an employer or as an individual. In addition to a retirement plan, your employer may offer other benefits that reduce your taxable income, such as a flexible spending account (FSA).
Kari also asked about I bonds, a US Treasury bond designed to protect investments from inflation with an interest rate that adjusts every six months. Your earnings are exempt from state and local taxes but not federal income taxes. However, you can defer taxation and report the earnings when you redeem or cash out a bond.
You can purchase up to $10,000 of electronic I bonds per year and may be able to buy an additional $5,000 using a tax refund. I bonds may pay higher interest rates than savings accounts or CDs, but they come with a penalty if you cash them out early.
Another type of bond, a municipal bond, can be free of federal, state, and local income taxes, depending on where you live and if you hold them until maturity. They can be subject to state and local taxes under certain circumstances.
How do married couples qualify for a Roth IRA?
Jennie asked what will happen to her and her fiance’s ability to make Roth IRA contributions after they get married. For 2024, the contribution limit for a Roth or traditional IRA equals your (or your spouse’s) earned income up to $7,000 or $8,000 if you’re over 50.
Unlike a traditional IRA, you can only contribute to a Roth IRA when you earn less than an annual threshold. The limit depends on your tax filing status and modified adjusted gross income (MAGI). Here are the 2024 income limits to qualify for a Roth IRA:
- Single taxpayers must have a MAGI of less than $161,000 but qualify for a reduced contribution from $146,000 to $160,000. You can make a full contribution with MAGI under $146,000.
- Married taxpayers filing jointly must have a MAGI of less than $240,000 but qualify for a reduced contribution from $230,000 to $239,000. You can both make full contributions with MAGI under $230,000.
- Married taxpayers filing separately must have a MAGI of less than $10,000 to qualify for a reduced contribution. However, you can use the single limits if you haven’t lived together in the past year.
Therefore, Jennie and her fiancé can use the limits for single taxpayers the first year they get married but must file jointly to get the most out of their Roth IRAs.
If you have a Roth IRA but become ineligible in the future, you can keep your account indefinitely and enjoy its tax-free growth. However, you can only make new contributions in years when your income is below the annual allowable limit.
Which medical expenses are tax-deductible?
Lisa asked how to get the most tax benefit from her medical expenses after she drains her FSA. If you’re not familiar with FSAs, they’re medical savings accounts offered by some employers.
Eligible employees can make pre-tax contributions from their paychecks to an FSA to pay eligible healthcare and dependent care expenses. You decide how much to put in the account, up to an annual limit. For 2024, the FSA contribution limit is $3,200. You must spend FSA funds annually or forfeit them after a short grace period, known as the “use-it-or-lose-it” rule.
In most cases, you can’t contribute to an FSA and an HSA in the same year. However, for those who don’t have an FSA, using an HSA is an excellent way to pay for many healthcare expenses tax-free if you have a qualifying health plan.
If you use your FSA funds or choose not to use HSA funds to pay healthcare expenses, many can be claimed as a tax deduction on your tax return, reducing your taxable income if you itemize deductions on Schedule A.
For 2024, your eligible unreimbursed healthcare costs that exceed 10% of your adjusted gross income (AGI) are tax-deductible. If you or your spouse is 65 or older, you can deduct expenses that exceed 7.5% of your AGI through 2026.
Let’s say you’re 45 with an AGI of $100,000 and spend 5% or $5,000 on qualified healthcare expenses. No expenses are deductible because they don’t exceed 10% of your AGI. But if your total expenses were $12,000, you could deduct $2,000 ($12,000 – $10,000) of them.
To be considered tax-deductible, healthcare expenses must be necessary to prevent, diagnose, treat, or alleviate a medical condition. They can be for you, a spouse, and your dependents. You can deduct healthcare costs the year you pay them regardless of when you received the goods or services.
Examples of potentially deductible healthcare expenses include:
- Fees paid to doctors, chiropractors, dentists, psychologists, and psychiatrists
- Hospital or nursing home care
- Prescription drugs
- Eye care, including exams, eyeglasses, and contact lenses
- Hearing tests and aids
- Medical equipment like crutches and wheelchairs
- Transportation to receive medical care, including ambulance service
- Fees paid for acupuncture and Christian Scientist practitioners
- Treatment for alcohol or drug addiction, including transportation to local prevention meetings
- Fertility treatments like in vitro fertilization and pregnancy test kits
- Lactation supplies
- Vasectomy and abortion procedures
- Home modifications to accommodate a disability
- Owning a guide dog or other service animal
- Smoking cessation programs
- Health insurance premiums–unless already excluded from your gross income by an employer
That’s not a complete list. You can review hundreds of deductible healthcare expenses in IRS Publication 502, Medical and Dental Expenses.
Note that if an expense is a tax-free benefit, reimbursed, or paid for using a HSA or FSA, it doesn’t qualify as a deductible. Nor can you deduct expenses like cosmetic procedures unrelated to a medical condition, health club memberships, teeth whitening, or funeral expenses.
You can reduce your taxable income and taxes by carefully documenting your eligible healthcare expenses throughout the year. Remember to maximize contributions to a workplace retirement plan or individual retirement account. These are a few ways to cut taxes and keep more of your hard-earned income.
If you have tax questions, consult a tax professional for clarification and help filing your taxes. They can help you get every legitimate tax break you’re entitled to and save more money.
This article originally appeared on QuickAndDirtyTips.com and was syndicated by MediaFeed.org.
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Are student loans tax deductible? A guide to rules & limits
Are student loans tax deductible? You betcha: If you paid on student loans in the prior tax year, you might qualify for the student loan tax deduction, which allows borrowers to deduct up to $2,500 in interest they paid from their taxable income.
Getting a refund? Whether you’re considering putting it toward skydiving for the first time or you’re planning to use it to pay off more student loan debt, here are some things you should know about the student loan interest deduction and whether you qualify.
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The student loan tax deduction isn’t a magical discount that’s taken off your monthly student loan payment like a coupon at the grocery store checkout. Instead, you pay the interest out of pocket throughout the tax year and claim the interest you paid when you do your taxes.
The interest applies to qualified student loans that were used for tuition and fees; room and board; coursework-related fees, books, supplies and equipment; and other necessary expenses, like transportation.
So how much student loan interest can you deduct? If you qualify for the full deduction, you deduct student loan interest up to $2,500 as long as you actually paid that much in interest. (You don’t need to itemize in order to get the deduction.)
Not only do required interest payments count, but if you made any additional interest payments toward your student loans in the past tax year, those count, too.
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To be eligible to deduct student loan interest, individuals must meet the following requirements:
- You paid interest on a qualified student loan (a loan for you, your spouse, or a dependent) during the tax year.
- Your modified adjusted gross income (gross income for the year minus certain deductions) is less than a specified amount that is set annually.
- Your filing status isn’t married filing separately.
- Neither you nor your spouse can be claimed as a dependent on someone else’s return.
- The loans in question can be federal or private student loans.
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Your modified adjusted gross income is calculated on your federal tax return before any student loan interest deduction is made. The eligible ranges are recalculated annually.
For tax year 2020 (filing in 2021), the student loan interest deduction was worth as much as $2,500 for a single filer, head of household or qualifying widow/widower with a MAGI of under $70,000.
For those three kinds of filers who exceeded a MAGI of $70,000, the deduction began to phase out, meaning the most they could deduct was less than $2,500. Once their MAGI reached $85,000, they were no longer able to claim the deduction.
For married couples filing jointly, the phaseout began after a MAGI of $140,000, and eligibility ended at $170,000.
Confused by all these requirements? If so, consider going to a tax professional to help with your return to make sure you can take advantage of the deduction.
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In addition to the student loan interest rate deductions, there are other tax breaks that may be available to you if you’re a student or you’re saving for or paying for certain education expenses for yourself, a spouse or a dependent.
Here’s a look.
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A 529 college savings plan is a tax advantaged plan that allows you to save for qualified education expenses — like tuition, lab fees and textbooks — for yourself or your children. You can contribute up to $15,000 per year without triggering gift taxes, and other family members can contribute to the fund, as well.
Savings can be invested and grow tax free inside the account. And while the Federal government doesn’t offer any tax deductions, some states will tax benefits like deductions from state income tax. Withdrawals must be used to cover qualified expenses; otherwise, you will face income taxes and a 10% penalty.
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The American Opportunity Tax Credit (AOTC) helps offset $2,500 in qualified education expenses per student per year for the first four years of higher education. Unlike a tax deduction, tax credits reduce your tax bill on a dollar-for-dollar basis. And if the credit brings your taxes to zero, 40% of whatever remains of the credit amount can be refunded to you, up to $1,000.
To be eligible for the AOTC, you must be getting a degree or another form of recognized education credential. And at the beginning of the tax year, you must be enrolled in school at least half time for one academic period, and you cannot have finished your first four years of higher education at the beginning of the tax year.
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The Lifetime Learning Credit (LLC) helps pick up where the AOTC leaves off. While the AOTC only lasts for four years, the LLC helps offset the expense of graduate school and other continuing educational opportunities. The credit can help pay for undergraduate and graduate programs, as well as professional degree courses that help you improve your job skills. The credit is worth $2,000 per tax return, and there is no limit to the number of years you can claim it. Unlike the AOTC, it is not a refundable tax credit.
To be eligible, you, a dependent or someone else must pay qualified education expenses for higher education or pay for the expenses of an eligible student and an eligible educational institution. The eligible student must be yourself, your spouse or a dependent that you have listed on your tax return.
Recommended: 26 Tax Deductions for College Students and Other Young Adults
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Unfortunately, you can’t deduct the entirety of your student loan payments from your taxes. As mentioned, you can only deduct your interest. Your loan provider reports information on interest paid on Form 1098-E, which is a tax form financial institutions generally send to borrowers when the tax year ends.
The only reason you wouldn’t receive one from your lender is if you paid less than $600 in interest on their loan. But these forms don’t always report things like the interest you paid on certain origination fees or capitalized interest, which may also qualify for the student loan deduction.
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To calculate the full value of the interest deduction, start with the amount of interest the form says you paid, and then add any interest you paid on qualified origination fees and capitalized interest. Just make sure these amounts don’t add up to more than the total you paid on your student loan principal.
Clear as mud, right? Hey, no one said the IRS makes things easy! Here are some examples of how to deduct these amounts.
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As of Sept. 1, 2004, this fee, usually a one-time fee that lenders charge for creating a new loan, is included on your 1098-E. For loans issued before that date, you can use any reasonable method to allocate the loan origination fees over the term of the loan. One way to do this is to figure out how much the fees will cost you monthly over the life of the loan.
Example: If the origination fee you were charged on your loan was $1,000 and the term length was 10 years, or 120 months, that would mean your origination fee would be $8.33 per month, or $100 per year.
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If your Form 1098-E says your loan has capitalized interest, you can also claim that after you’ve claimed an origination fee deduction. Capitalized interest accrues and then is added to the loan principal if you don’t pay it. Unsubsidized federal loans, for example, accrue interest while the student is in school and during the loan’s grace period. It’s common for that interest to be capitalized (added to principal) at the end of the grace period.
Example: If you made $6,000 in student loan payments, of which $1,000 went to interest and $5,000 to principal, you can claim the $100 you paid toward your origination fee and the full $1,000 in capitalized interest. But if you only paid off $750 of your principal, you can claim $650 of the $1,000 of capitalized interest, because you’ll have to claim the $100 in origination fees first and you can’t exceed the amount you paid toward your principal.
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Tax credits and deductions are one way to help pay for the cost of school. Finding ways to lower your student loan payments is another cost-saving measure. Here are a few ideas:
- Make additional payments to pay down your principal. Doing this may help reduce the amount of interest you will owe less interest over the life of the loan, but beware of any prepayment penalties.
- Make interest only payments while you’re still in school. This may prevent thousands of dollars from being added to your loan principal (or capitalized on the loan) once you graduate.
- See whether your loan provider offers discounts if you set up automatic payment. Federal Direct Loan holders may be eligible for a 0.25% discount when they sign up for automatic payments.
- Consider student loan refinancing, replacing your student loan to a new loan with a lower interest rate or more favorable terms. If you refinance federal loans, however, they are no longer eligible for federal benefits or protections.
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Who doesn’t love a tax deduction? Qualified filers can take a student loan interest deduction of up to $2,500 atop the standard deduction. Most private and federal student loans are fair game.
Learn More:
This article
originally appeared on SoFi.comand was
syndicated by MediaFeed.org.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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