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 you can exclude up to $250,000 of your gain on your home's sale, per person. 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. Plunking money into a traditional IRA removes those funds from your taxable 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 escape paying tax on that $3,000, for approximate savings of $750. 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 for you. You get to designate how much of your paycheck gets diverted directly into it. Since that money doesn't wind up in your final check, it's not counted as part of your income. (Want details? Visit our 401(k) nook.)
Note that while 401(k)s usually have you distributing your money among mutual funds, money market funds, and such, IRAs let you invest in individual stocks. Are you attracted to Dell's incredible track record of stock appreciation in the past decade? Do you believe strongly in Netflix's (NASDAQ:NFLX) future, with its 5.7 million subscribers? If you think they'll help you save for retirement, you can invest in both via your IRA. Similarly, if you're bullish on stocks with apparent growth engines like Coach (NYSE:COH), or impressed by its recent growth spurts, you can invest thousands of dollars in it directly. That can be much more effective than just owning a mutual fund that has 0.5% of its assets in Coach.
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'd 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'd have $216,410 in 20 years. That's a $71,848 difference!
Take some time to learn about these and other tax benefits available to you. Your retirement will thank you for it. Learn more in our IRA Center.
This article was originally published on Feb. 8, 2006. It has been updated by Fool sector head Joey Khattab, who does not own any of the shares mentioned. Netflix and Dell are Motley Fool Stock Advisor picks. Dell is also an Inside Value recommendation. The Fool has a disclosure policy.
