Yes, Uncle Sam likes to take your hard-earned money. That doesn't mean you have to give him as much as he wants, though. Take a little time to learn about tax issues, and you may be surprised at how much you can save.
For example, you may be able to sell your house and keep all the profits -- tax-free! Play by the rules and an individual can exclude up to $250,000 of the gain on a home sale. If you're married, that amounts to $500,000 of tax-free gains.
Here's a smaller-scale example, but one you can tap every year: retirement savings. Plunk money into a traditional IRA and you get to remove it from your income. If you made $45,000 this year and contributed $3,000 to a traditional IRA, you'd report $42,000. If you're in a 25% tax bracket, you'd avoid paying $750 in taxes on that $3,000. Not bad, eh? (Of course, for many -- if not most -- of us, Roth IRAs make even more sense. Learn all about IRAs in our IRA Center.)
The 401(k) that may be available at your workplace is a similar tax-avoiding device. You get to designate how much of your paycheck goes directly into it before you ever receive the money. So it's not counted as income to you. (Want details? Visit our 401(k) nook.)
Note that while 401(k)s usually have you distributing your money between mutual funds and money market funds, IRAs often allow you to invest in individual stocks. So if you're attracted by Dell's (NASDAQ:DELL) incredible track record of stock appreciation (its value increased 35-fold over the past decade, for example) or you believe strongly in Netflix's (NASDAQ:NFLX) future (it recently returned to profitability, with revenues and subscribers up 37% and 53%, respectively, over year-ago levels) and think it will serve you well as you save for retirement, you can invest in them via your IRA.
Small sums turn into surprisingly sizable ones if you leave them invested for long periods. Consider these examples: If you sock away $2,000 a year (or $167 per month) in an IRA, you'll end up with $144,562 after 20 years (assuming an average annual return of 11%). However, if you contribute a mere $1,000 more each year, for a total of $3,000 ($250 a month), you'll have $216,410 in 20 years. That's a $71,848 difference! Better still, beginning in tax year 2005 (this year), you can contribute up to $4,000 annually to an IRA, and even a little more if you're 50 or older.
Take some time to learn about these and other tax benefits available to you. Your retirement will thank you for it.
And to receive valuable retirement guidance delivered to your mailbox every month, check out a free trial of our Rule Your Retirement newsletter. Robert Brokamp heads it up -- get a taste of his smarts and style in these articles:
- Do You Want to Work Forever?
- Stop Eating Your Retirement!
- Get Rich by Beating the Odds
- Annuities: Who Needs Them?
Longtime Fool contributor Selena Maranjian owns shares of Netflix. The Fool has a strict disclosure policy.
