
your financial details.
A wealth tax is a type of tax that’s imposed on the net wealth of an individual. This is different from income tax, which is the type of tax you’re likely most used to paying. The U.S. currently doesn’t have a wealth tax, though the idea has been proposed more than once by lawmakers. Instituting a wealth tax could help generate revenue for the government but only a handful of countries actually impose one.
Wealth Tax, Definition
A wealth tax is what it sounds like: a tax on wealth. This can also be referred to as an equity tax or a capital tax and it applies to individuals.
More specifically, a wealth tax is applied to someone’s net worth, meaning their total assets minus their total liabilities. The types of assets that may be subject to inclusion in wealth tax calculations might include real estate, investment accounts, liquid savings and trust accounts.
A wealth tax isn’t the same as other types of tax you’re probably familiar with paying. For example, you might be used to paying income tax on the money you earn each year, self-employment tax if you run a business or work as an independent contractor, property taxes on your home or vehicles and sales tax on the things you buy.
Instead, a wealth tax has just one focus: taxing a person’s wealth. According to the Tax Foundation, only Norway, Spain and Switzerland currently have a net wealth tax on assets. But a handful of other European countries, including Belgium, Italy and the Netherlands, levy a wealth tax on selected assets.
How a Wealth Tax Works
Generally, a wealth tax works by taxing a person’s net worth, rather than the income they earn in a given year. In countries that impose a wealth tax, the tax is only levied once assets reach a certain minimum threshold. In Norway, for instance, the net wealth tax is 0.85% on stocks exceeding $164,000 USD in value.
Wealth taxes can be applied to all of the assets someone owns or just some of them. For example, the wealth tax can include securities and investment accounts while excluding real property or vice versa.
Every country that imposes a wealth tax, whether it’s a net tax or a tax on selected assets, can set the tax rate differently. It’s not uncommon for there to be exemptions or exclusions to who and what can be taxed this way.
A wealth tax can be charged alongside an income tax to help generate revenue for the government. The wealth tax rates are typically lower than income tax rates, in terms of the actual percentage rate, but that doesn’t necessarily mean paying less in taxes. Someone who has substantial assets that are subject to a wealth tax, for instance, may end up paying more toward that tax than income tax if they’re able to reduce their taxable income by claiming tax breaks.
Is a Wealth Tax a Good Idea?
In countries that use a wealth tax, the revenue helps to fund government programs and organizations. In some places, such as Norway, revenue from the wealth tax is split between the central government and municipal governments. It would be up to the federal government to decide how wealth tax revenue should be allocated if one were introduced here.
In the U.S., the concept of a wealth tax has been used to argue for a redistribution of wealth. Or more specifically, lawmakers who back the tax have suggested that it could be used to more fairly tax the wealthy while relieving some of the tax burdens on lower and middle-income earners. While wealthier taxpayers may take advantage of loopholes to minimize income taxes, a wealth tax would be harder to work around, at least in theory. That could yield benefits for less wealthy Americans if it means they’d owe fewer taxes.
That sounds good but implementing and collecting a wealth tax may be easier said than done. It’s possible that even with a wealth tax in place, high-net-worth and ultra-high-net-worth taxpayers could still find ways to minimize the amount of tax they’d owe. And the tax itself could be seen as unfairly penalizing wealthier individuals who own charities or foundations, invest heavily in businesses or save and invest their money instead of using it to buy things like luxury cars, expensive homes or other physical assets.
It’s important to keep in mind that a wealth tax is targeted at people above certain wealth thresholds, so most everyday Americans wouldn’t have to pay it. But it could cause problems for someone who unexpectedly receives a large inheritance that increases his wealth, even if his income remains at the lower end of the scale.
The Bottom Line
In the U.S., the wealth tax is still just an idea that’s being floated by progressive politicians and lawmakers. Whether a wealth tax is ever implemented remains to be seen and it’s likely that debate over it may continue for years to come. And enforcing one could be difficult if it were ever introduced, if for no other reason than there are many ways for the extremely wealthy to avoid taxes. In the meantime, talking with a tax professional may be the best way to manage your own personal tax liability.
Tips on Taxes
- Consider talking to your financial advisor about the best ways to handle taxes as you grow an investment portfolio. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help you connect with professional advisors online. It takes just a few minutes to get your personalized financial advisor recommendations. If you’re ready, get started now.
- Managing taxes is an important part of growing wealth and creating an estate plan. The less you pay in taxes, the more money you have to save and invest toward establishing a legacy of wealth. A free income tax calculator is a good way to start figuring what you owe or to get confirmation that your calculations are correct.
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A Comprehensive Guide to 2020 Tax Credits

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Every year, people’s lives change in ways that affect their taxes. They may start a higher education program or have a child, and others take on elderly parents as dependents. These situations can change their eligibility for tax credits. In addition, federal, state and local governments sometimes adjust rules about credits, so it is crucial to understand what credits you can take. Navigating the world of tax credits and deductions can be confusing. That is why a trusted financial advisor can help you find every tax credit you are entitled to.
What a Tax Credit Is (and Isn’t)
Tax credits encourage people to spend money by giving them credit toward that expense. For example, one of the most common tax credits is the Child Tax Credit. Taxpayers who have children under the age of 17 receive a credit to help reduce the cost of raising a child. Another popular tax credit is the Lifetime Learning Credit (LLC). The LLC encourages people to pursue further education by crediting part of the overall cost back at tax time.
A tax deduction lowers one’s taxable income, thus reducing the tax liability. If a person receives a deduction, he decreases the amount from his income, which lowers his taxable income. The lower a person’s taxable income, the lower the tax bill.
By contrast, a tax credit decreases the tax bill rather than a person’s taxable income. So, if a person has a $100,000 salary and has a $10,000 deduction, the taxable income will be $90,000. If the person in this example is taxed at a rate of 25%, the tax bill will be $22,500. If that same person has a $10,000 credit instead of a deduction, he will be taxed at 25% of their $100,000 income and owe $25,000 in taxes. However, he will then be credited $10,000 and owe only $15,000.
Some tax credits are refundable, but most are not. A refundable tax credit, which is different from a tax refund, can be given to taxpayers even if they do not owe any taxes. Additionally, a refundable tax credit can be given in addition to a tax refund. A nonrefundable tax credit means that a person will get the tax credit up to the amount owed. For example, if a person owes $2,000 in taxes and receives $3,000 in nonrefundable credits, that will simply erase her tax bill. If she gets $3,000 in refundable credits, she will receive a $1,000 tax refund.
Some common tax credits for individuals include:
- Child Tax Credit
- Earned Income Tax Credit
- Credit for Other Dependents
- Adoption Credit
- Low-Income Housing Credit
- Premium Tax Credit (Affordable Care Act)
- American Opportunity Credit
- Lifetime Learning Credit
Child Tax Credit
The Child Tax Credit is a refundable credit up to $1,400 and offers up to $2,000 per qualifying child age 16 or younger. Parents of children who are 16 or younger as of Dec. 31, 2020, can qualify for this tax credit. For someone to be eligible for the Child Tax Credit, the modified adjusted gross income must be under $400,000 if the parents of the child(ren) file jointly and $200,000 for any other person filing.
Additional requirements to qualify for the child tax credit include that the person filing must have provided at least half of the child’s support in the calendar year, and the child must have lived with the person filing for at least half the year. There are some exceptions to this rule, and it is best to discuss the child tax credit with a tax advisor.
Child and Dependent Care Credit
The cost of childcare, eldercare and other in-home care in the U.S. is high and tends to rise each year. If a couple is married and files jointly and has paid expenses for the care of a qualifying child or dependent so that one or both can work, they are likely eligible for the Child and Dependent Care Credit.
To qualify for the Child and Dependent Care Credit, the taxpayers must have received taxable income. This is because the credit is designed to help individuals who need to hire a caretaker to stay in the workplace.
Additionally, there are several qualifiers on the person being cared for. A child must be under age 13 when the care was provided. A qualifying spouse must be unable to take care of himself and have lived in the taxpayer’s home for at least half the year. A qualifying dependent must be physically or mentally incapable of caring for himself, have lived with the taxpayer for at least half the year and is either a dependent or could have been a dependent of the taxpayer. A taxpayer can claim up to $3,000 of expenses for one child or dependent and up to $6,000 for two or more children or dependents.
There are limits on who can provide care to qualify for this tax credit. The caregiver must not have been the taxpayer’s spouse, a parent of the child being cared for or anyone else listed as a dependent on the tax return. Additionally, the caregiver can’t be a child of the taxpayer.
Any child support payments you’ve received won’t be counted as taxable income. And if you’re the one making the child support payments, the income you used to do so won’t be tax deductible.
Federal Adoption Credit
Families that grow through adoption might be eligible for the Federal Adoption Tax Credit. Adoption can be an expensive process, and as families take on the burden of legal fees and more, the Federal Adoption Credit can help to decrease the burden when filing taxes.
To be eligible for the full credit, adoptive parents must earn $214,520 or less, regardless of their filing status. The credit is up to $ 14,300 per eligible child. An eligible child is any person under the age of 18 that is mentally or physically unable to take care of themselves. Eligible expenses include court costs, attorney fees, home studies and other travel expenses related to the adoption. The Federal Adoption credit is nonrefundable, so it will not produce a refund.
There are several rules for the Federal Adoption Credit, so it is important to speak with your tax advisor before claiming this credit. For example, if you received employer-provided adoption benefits, you may not claim the same expenses that were covered by your employer for the Federal Adoption Credit.
Credit for Other Dependents
The Credit for Other Dependents is a tax credit available for taxpayers who do not qualify for the Child Tax Credit. For example, someone who has a child age 17 or older or has other adult dependents with an Individual Taxpayer Identification Number might qualify for this credit. This tax credit amount is $500 for each dependent that qualifies for the tax credit. The credit is available in full to a taxpayer who earns $200,000 or less and decreases on a sliding scale as that person’s income increases.
An example of someone eligible for the Credit for Other Dependents is a single person filing who has a child dependent that is 17 years old and another child who is 21 and in college. Both children would likely qualify as dependents, and each would be eligible for the $500 credit. Another example is if someone has an adult relative living with him listed as a dependent on his tax return. In any case, the dependent must be a U.S. citizen, national or resident alien.
Lifetime Learning Credit
To promote education in the United States, the IRS created a tax credit called the Lifetime Learning Credit (LLC). This credit is for qualified tuition and expenses paid for qualified students at qualified institutions in the United States.
To claim the LLC, a person, their spouse or their dependent must pay qualified higher education expenses. Additionally, the student must be enrolled at an eligible educational institution. Eligible educational institutions are colleges, technical schools and universities offering education beyond high school. All qualified educational institutions are eligible to participate in a student aid program run by the U.S. Department of Education. The IRS publishes a list for people to search if their school is a qualified educational institution.
To receive the LLC, a person must have received a 1098-T tuition statement from the higher education institution. The credit is worth 20% of the first $10,000 that a person spends at the higher education institution. For example, if a person started school at a university in the fall semester and tuition cost $10,000 or more, that person would receive a credit of $2,000. The LLC is not refundable, so a person can use the credit for taxes who owe but will not receive the credit as a refund.
Additionally, the LLC has income limits. In 2020, a person’s income must be $69,000 or lower if filing single and less than $138,000 if filing jointly to receive any of the LLC. To be eligible for the full LLC amounts, a person can earn up to $118,000 filing jointly or $59,000 filing single.
The Retirement Contribution Savings Credit
The Saver’s Credit, or the Retirement Contribution Savings Credit, has been around since the early 2000s. It was created to help low- and moderate-income individuals save for retirement. Depending on a taxpayer’s income, the Saver’s Credit is worth 10%, 20% or 50% of her total savings contribution up to $1,000, or $2,000 if a person is filing jointly.
For example, if a person is filing single, her income qualifies her for the 50% credit tier, and if she contributes $2,000 to an IRA, she can receive a credit of $1,000. The maximum credit is $1,000, so if the same person decides to contribute $2,500 to an IRA, she will still receive a $1,000 tax credit.
Earned Income Tax Credit
An Earned Income Tax Credit (EITC) reduces the tax bills for low- to moderate-income working families. The credit ranges from $538 to $6,660 depending on a taxpayer’s filing status, how many children they have and their earned income. This amount changes every year, so be sure to verify the EITC with a tax advisor or verify with the IRS.
To qualify for the EITC, a taxpayer must have earned taxable income from a company, running a farm or owning a small business. People who do not earn an income, are married filing separately or do not have a Social Security number are not eligible for this credit. Additionally, people who earned over $3,650 in investment income are ineligible for this tax credit.
To earn the maximum EITC, a single filer can earn $50,594 or less, and a joint filer can earn $56,844 or less and have three or more dependent children. The amount of the EITC credit decreases if a taxpayer has fewer children.
American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) is available to eligible students in the first four years of higher education. Students must be pursuing a degree or other recognized credential, be enrolled at least half time for at least one academic period or semester, not have received the AOTC or the Hope credit for more than the past four years and not have a felony drug conviction at the end of the tax year.
Students may receive up to $2,500 of credit for the AOTC. The credit is refundable up to 40%, so if a student is eligible for the full $2,500 and receives a tax return, the student can receive up to $1,000. The credit is awarded for 100% of the first $2,000 of qualified educational expenses and 25% of the next $2,000 of educational expenses. Therefore, if a student pays at least $4,000 in educational expenses, he will receive the full $2,500.
To prove they are eligible, students must receive a 1098-T from their educational institution. A taxpayer’s modified adjusted gross income must be $80,000 or less, or $160,000 or less for a married couple filing jointly to receive the full AOTC. If the student is a dependent, the taxpayer may claim the AOTC when filing taxes.
An example of someone claiming the AOTC is a parent who earns $79,900 and has a student in the first four years of a degree program. Another example of someone eligible is a student who is not a dependent of anyone and works part-time, earning $80,000 or less. If you are unsure if you or your family qualifies for this tax credit, be sure to speak with a tax advisor.
The Takeaway
There are many tax credits that American taxpayers can take advantage of. These credits were created to encourage spending in specific areas of the economy and help low- and moderate-income families prosper. In addition to tax credits, there are plenty of other ways to keep more money in your pockets during tax season. Be sure to check out the IRS website to learn more about other tax credits, including the Residential Energy Efficient Property Credit, Foreign Tax Credit and more.
Tips on Taxes
- Navigating the world of tax deductions and credits can be cumbersome and confusing. That is why it is so valuable to work with a financial advisor. Finding one doesn’t have to be difficult. SmartAsset’s matching tool can connect you with several financial advisors in your area within minutes. If you’re ready, get started now.
- Using a free tax return calculator can help confirm that you did your arithmetic correctly … or indicate that you may have missed a credit or deduction.
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How to Avoid Paying Taxes on a Savings Bond

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Savings bonds can be a safe way to save money for the long term while earning interest. You might use savings bonds to help pay for your child’s college, for example, or to set aside money for your grandchildren. Once you redeem them, you can collect the face value of the bond along with any interest earned. It’s important to realize, however, that interest on savings bonds can be taxed. If you’re wondering, how you can avoid paying taxes on savings bonds there are a few things to keep in mind. Of course, one key thing to keep in mind is that a financial advisor can be immensely helpful in minimizing your taxes.
How Savings Bonds Work
Savings bonds are issued by the U.S. Treasury. The most common savings bonds issued are Series EE bonds. These electronically issued bonds earn interest if you hold them for 30 years. Depending on when you purchased Series EE bonds, they may earn either a fixed or variable interest rate.
You can buy up to $10,000 in savings bonds per year if you file taxes as a single person. The cap doubles to $20,000 for married couples who file a joint return. If you decide you want to use some or all of your tax refund money to purchase savings bonds, you can earmark an additional $5,000 for Series I bonds. These are paper bonds, not electronic ones.
When Do You Pay Taxes on Savings Bond Interest?
When you’ll have to pay taxes on Treasury-issued savings bonds typically depends on the type of bond involved and how long you hold the bond. The Treasury gives you two options:
- Report interest each year and pay taxes on it annually
- Defer reporting interest until you redeem the bonds or give up ownership of the bond and it’s reissued or the bond is no longer earning interest because it’s matured
According to the Treasury Department, it’s typical to defer reporting interest until you redeem bonds at maturity. With electronic Series EE bonds, the redemption process is automatic and interest is reported to the IRS. Interest earnings on bonds are reported on IRS Form 1099-INT.
It’s important to keep in mind that savings bond interest is subject to more than one type of tax. If you hold savings bonds and redeem them with interest earned, that interest is subject to federal income tax and federal gift taxes. You won’t pay state or local income tax on interest earnings but you may pay state or inheritance taxes if those apply where you live.
How Can I Avoid Paying Taxes on Savings Bonds?
Whether you have to pay taxes on savings bonds depends on who owns it. Generally, taxes are owed on interest earned if you’re the only bond owner or you use your own funds to buy a bond that you co-own with someone else.
If you buy a bond but someone else is named as its only owner, they would be responsible for the taxes due. When you co-own a bond with someone else and share in funding it, or if you live in a community property state, you’d also share responsibility for the taxes owed with your co-owner or spouse.
Use the Education Exclusion
With that in mind, you have one option for avoiding taxes on savings bonds: the education exclusion. You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you’re using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent. Only certain qualified higher education costs are covered, including:
- Tuition
- Fees
- Some books
- Equipment, such as a computer
You can still use savings bonds to pay for other education expenses, such as room and board or activity fees, but you wouldn’t be able to avoid paying taxes on interest.
Additionally, there are a few other rules that apply when using savings bonds to pay for higher education:
- Bonds must have been issued after 1989
- Bond owners must have been at least 24 years of age at the time the bonds were issued
- Education costs must be paid using bond funds in the year the bonds are redeemed
- Funds can only be used to pay for expenses at a school that’s eligible to participate in federal student aid programs
If you’re married you and your spouse have to file a joint return to take advantage of the education exclusion. And any money from a savings bond redemption that doesn’t go toward higher education expenses can still be taxed at a prorated amount.
There are also income thresholds you need to observe. For 2020, single tax filers can earn up to $82,350 and benefit from the full exclusion. Married couples filing jointly can do so with up to $123,550 in income. Once your income passes those limits, the amount of interest you can exclude is reduced until it eventually phases out altogether.
Roll Savings Bonds Into a College Savings Account
Another strategy for how to avoid taxes on savings bond interest involves rolling the money into a college savings account. You can roll savings bonds into a 529 college savings plan or a Coverdell Education Savings Account (ESA) to avoid taxes.
There are some advantages to either approach. With a 529 college savings plan, you can continue saving money on a tax-advantaged basis for higher education. You won’t pay any taxes on money that’s withdrawn for qualified education expenses. And if you have multiple children, you can reassign the account to a different beneficiary if one child decides he or she doesn’t want to go to college or doesn’t use up all the money in the account.
Contributions to 529 college savings accounts aren’t tax-deductible at the federal level, though some states do allow you to deduct contributions. You don’t have to live in any particular state to invest in that state’s 529 and plans can have very generous lifetime contribution limits. Keep in mind that gift tax exclusion limits still apply to any money you add to a 529 on a yearly basis.
Coverdell ESAs have lower annual contribution limits, capped at $2,000 per child. You can only contribute to one of these accounts on behalf of a child up to their 18th birthday. Withdrawals are tax-free when the money is used for qualified education expenses. But you have to withdraw all the funds by age 30 to avoid a tax penalty.
The Bottom Line
Savings bonds typically offer a lower rate of return compared to stocks, mutual funds or other higher-risk securities. But they can be a good savings option if you want something that can earn interest over the long term. Minimizing the taxes you pay on that interest may be possible if you have children and you plan to use some or all of your savings bonds to help pay for college. Talking to a tax professional can also help with finding other college tax savings strategies.
Tips for Investing
- Consider talking to a financial advisor about the best ways to manage savings bonds in your portfolio. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool can make it easy to connect with professional advisors locally in just minutes. If you’re ready, get started now.
- Savings bonds purchased on behalf of grandchildren don’t receive the same tax treatment for higher education purposes. Generally, the education exclusion only applies if the grandparent is claiming a grandchild on their taxes as a dependent. If your parents are interested in helping pay for your child’s college expenses, you may encourage them to open a 529 college savings account instead, then roll the bonds into it to avoid paying taxes on interest earned.
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Strategies for Avoiding and Reducing Taxes

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Taxes can take a big bite out of your income, especially if you’re in a higher income tax bracket. And even with careful planning, it’s possible that you could still be hit with an unexpected tax bill. The good news is, there are things you can do to keep more of your hard-earned dollars in your pocket instead of handing them over to the IRS. If you’re interested in how to avoid paying taxes legally or at the very least, minimize your tax liability each year, these tips and strategies can help.
How to Avoid Paying Taxes With Tax Deductions
Deductions can be a taxpayer’s best friend since they enable you to reduce your taxable income for the year. In simple terms, it’s an amount you deduct from your income.
When filing taxes, it’s important first to determine whether you want to claim the standard deduction or itemize deductions. The standard deduction is a flat dollar amount that you can deduct from your income. Your individual standard deduction is based on your filing status. Here are the standard deduction amounts for 2020 and 2021:
2020 Standard Deduction
2021 Standard Deduction
- $12,550 for single filers or married couples filing separately
- $25,100 for married couples filing jointly
- $18,800 for head of household
If you choose the standard deduction, you wouldn’t be able to itemize. Itemizing deductions means listing out individual expenses that you want to deduct from your taxable income. Generally, it makes sense to itemize if doing so would yield a larger tax benefit versus claiming the standard deduction.
The IRS allows you itemize and deduct a lengthy list of expenses, including:
The amount you can deduct depends on the deduction itself. With the mortgage interest deduction, for example, you can deduct interest expenses on up to $750,000 of mortgage debt if you purchased your home after December 15, 2017. If you bought your home before then, the old deduction limit of up to $1 million still applies.
Additionally, you may have options for how to avoid paying taxes at the state level if your state offers additional deductions. For instance, some states allow you to deduct contributions to a 529 college savings account.
Reduce Taxes With Above-the-Line Deductions
There are some tax deductions you can claim even if you don’t itemize. These are called above-the-line deductions and they’re subtracted from your income before your adjusted gross income is calculated.
Examples of above-the-line deductions you might be able to claim include:
- Educator expenses
- Health savings account contributions
- Moving expenses if you’re an active-duty military member
- Half of your self-employment tax
- Self-employed retirement plan contributions
- Health insurance premiums you pay out of pocket if you’re self-employed
- Savings account and certificate of deposit account early withdrawal penalties
- Traditional IRA contributions
- Traditional 401(k) contributions
- Student loan interest
- Tuition and fees
- Alimony payments
You don’t need to itemize to claim above-the-line deductions. But it’s important to note that if you do decide to itemize, the amount of above-the-line deductions you take can affect any below the line or itemized deductions you might be eligible for.
When itemizing or taking above-the-line deductions, the IRS can impose thresholds on how much you can deduct. There can also be income limits for who can claim a particular deduction. The higher your income, the more your deduction amount may be reduced until it’s phased out eventually.
For example, say you’re covered by a retirement plan at work but you also contribute money to a traditional IRA. If you’re single or file head of household and have a modified adjusted gross income of $65,000 or less, you can deduct your entire contribution up to the annual contribution limit. But you can only take a partial deduction if your modified AGI is more than $65,000 and less than $75,000. Once you reach $75,000 you wouldn’t be able to deduct any part of your traditional IRA contribution.
Reduce Taxes Using Credits
Credits can also help to lower your tax bill but they work differently from deductions. Instead of reducing your taxable income, credits reduce your tax liability dollar for dollar. So if you owe $2,000 in taxes and you receive a credit worth $500, your net tax liability would be $1,500. Similar to deductions, there are a variety of tax credits you may be able to claim, based on your filing status and income. Some of the most popular tax credits include:
- Child tax credit
- Credit for other dependents
- Child and dependent care credit
- Earned income tax credit
- Retirement contribution savings credit
- American opportunity tax credit
- Lifetime learning credit
Again, just like with deductions the IRS imposes limits on how much credit you can claim and who can claim them. For example, the earned income tax credit is designed for people who have earned income for the year that’s below certain thresholds. A single filer with no children could be eligible for the credit for the 2020 tax year if their adjusted gross income doesn’t exceed $15,820. The maximum credit they’d be able to claim would be $538.
It’s possible to claim both tax credits and deductions on your tax return but generally, you can’t claim for the same expenses. For example, you can’t take a tuition and fees deduction in the same tax year that you claim the American opportunity tax credit or the lifetime learning credit. The IRS requires you to pick one or the other, so it’s important to do the math to figure out which one will yield the biggest tax break.
How to Pay Less In Taxes Each Year
Understanding the difference between standard, itemized and above-the-line deductions as well as tax credits is a first step in cutting your tax bill. Beyond that, you can consider whether any of these actionable strategies fit into your tax plan:
- Contribute to your employer’s 401(k) and max out your plan if possible
- Open and contribute to a traditional IRA and/or health savings account (HSA)
- Deduct your mortgage interest and student loan interest
- Make charitable donations for a tax deduction
- Harvest capital losses in your investment portfolio
- Start a side hustle or business and claim deductible expenses
When claiming any sort of tax break, it’s important to keep a paper trail documenting your expenses. Some of this is made easier for you. If you pay mortgage interest, for example, you should receive a Form 1098 – Mortgage Interest Statement from your lender at the end of the year. You should also receive statements from your 401(k), IRA or HSA showing how much you contributed for the year.
In the case of charitable donations or business expenses, you’ll need to keep accurate records yourself. When making donations, for instance, you should get something in writing showing when the donation was made, how much was donated if you gave cash to charity and the name and address of the organization. If you’re donating items, you’d want to keep an itemized list of what was donated and their value.
Keeping a paper trail can help ensure that you’re reporting deductible expenses accurately. And it can also help prove your deduction claims if your tax return is selected for an audit.
The Bottom Line
There’s no magic formula for how to keep more of your hard-earned money. Instead, it comes down to proper planning to make sure that you’re taking advantage of every available tax break. One of those is using tax credits; another one is claiming all the above-the-line tax deductions you’re entitled to. Talking to a tax professional can help you pinpoint opportunities for saving on taxes that you may have otherwise overlooked.
Tips for Financial Planning
- Consider talking to a financial advisor about different tax strategies you can use to cut your tax bill. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help you find a professional advisor in your local area. If you’re ready, get started now.
- Even though you file taxes in April, reducing your tax bill is something you can and should be thinking about all year long. For example, instead of waiting until the end of the year to harvest losses in your portfolio to offset capital gains, you could do that quarterly.
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How to Avoid Paying Taxes on a Bonus Check

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The satisfaction of receiving a year-end bonus may soon be tempered by the realization that income taxes will have to be paid on the extra money. Bonuses are treated as income and thus subject to taxation, but there are ways to manage and reduce the amount of taxes that will be owed. And as is the case with other income from an employer, the employer is required to withhold taxes from a bonus, reducing your take-home pay from the windfall.
Most major employers award some type of bonuses, according to a September 2020 survey of large employers by Willis Towers Watson. Next year, about two out of three big employers plan to award annual performance bonuses, and nearly that many will keep the size of the bonus pool the same as this year, according to the survey. Only about one in 10 don’t plan to give annual performance bonuses at all in 2021.
Bonus Tax Strategies
Strategies to manage the taxes you’ll have to pay on a bonus fall into two camps. First, you can reduce your gross income. Second, you can increase the deductions that apply to your income.
Make a Retirement Contribution
One of the most effective ways to reduce taxes on a bonus is to reduce your gross income with a contribution to a tax-deferred retirement account. This could be either a 401(k) or an individual retirement account (IRA). The amount you donate to the retirement account, subject to limitations, reduces your taxable income so you’ll owe less.
The limitations are different for different types of retirement accounts. They also change from year to year. For 2020, the limits are;
- 401(k): $19,500
- IRA: $6,000, or $7,000 for taxpayers age 50 or older.
You can’t get a deduction for a contribution to a Roth IRA.
Contribute to a Health Savings Account
If you’re covered by a high-deductible health plan, you may be eligible to make a contribution to a health savings account (HSA). These contributions reduce your gross income by the contributed amount. You can also withdraw from an HSA to pay qualified medical expenses without incurring taxes, which makes this one of the most attractive tax-management strategies.
There are limits on how much you can contribute to your HSA. For 2020, the HSA contribution limit is $3,500 for an individual and $7,000 for a family.
Defer Compensation
You may be able to save on taxes by asking your employer to delay paying the bonus until January. If the bonus would push your income into a higher tax bracket this year and you expect less income next year, this strategy makes considerable sense. Even if you will still be in the same tax bracket, you benefit by delaying the day you have to pay the taxes by a year.
Donate to Charity
If you itemize your deductions rather than taking the standard deduction, you can make a contribution to a charity to reduce your taxable income. You may want to consider bunching donations by making two years’ worth of planned donations this year. You can donate up to 50% of your adjusted gross income to a qualifying charity, including nonprofits promoting literacy, education and amateur athletics as well as religious charities.
Pay Medical Expenses
If you itemize deductions and have medical or dental bills that weren’t reimbursed by insurance, you can reduce your taxable income by using the bonus to pay for them. You can only deduct unreimbursed medical and dental expenses if they are at least 10% of adjusted gross income.
Request a Non-Financial Bonus
You may be able to reduce taxes on your bonus to zero by asking your employer to make it a non-financial bonus. Examples of non-financial bonuses could include the ability to work from home or work flexible hours. Not all non-financial bonuses are tax-free, however. If you get extra paid vacation time in lieu of a check, for instance, it can be taxed as a financial bonus.
Supplemental Pay vs. Regular Pay
If your employer delivers the bonus to you as part of your regular paycheck, it will be taxed like regular income. If it’s delivered with a separate check, it’s taxed as supplemental income. The difference is that supplemental income is taxed at a flat 22% while regular income is taxed at your regular rate.
It is usually less costly to have the bonus delivered as supplemental income rather than as an amount added to your regular check. You may be able to get your employer to pay you so the bonus is regarded as supplemental income. However, which approach will result lower taxes depends on your individual situation.
Bottom Line
Year-end bonuses are subject to taxation just like any income received from an employer. There are some strategies that can help manage or reduce the taxes owed on a year-end bonus, however. Some of these require donating to charity or making a contribution to a retirement or health savings account. Others, such as deferring compensation, will call for some coordination with your employer.
Tips on Taxes
- If you anticipate a bonus, it’s a good idea to talk over the options for reducing taxes with an experienced financial advisor. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Be sure you are paying what you owe in federal taxes on your income – and no more. Using a free income tax calculator can help you know for certain that you are paying the correct amount.
Photo credit: ©iStock.com/fizkes, ©iStock.com/mixetto, ©iStock.com/Soulmemoria
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6 Tips to Find Affordable Health Insurance When You Become Self-Employed
Becoming self-employed or leaving a job for any reason doesn’t mean you can’t get affordable health insurance. Laura covers six tips to find a health plan so you and your family get the coverage you need no matter your employment situation.
Tax Cuts and Jobs Act, the mandate penalty for not having health insurance no longer applies. Technically, it’s still illegal to be uninsured, but the federal government won’t penalize you for it.
But several states have their own insurance mandates, requiring you to have a qualifying health plan. You may have to pay the penalty for being uninsured if you live in:
- California
- District of Columbia
- Massachusetts
- New Jersey
- Rhode Island
- Vermont
For example, California residents without ACA coverage in 2020 face a penalty up to 2.5% of household income, or $696 per adult, and $375.50 per child, whichever is greater. So, even if the federal government won’t penalize you for being uninsured, you could have to pay a hefty state penalty, depending on where you live. More states will likely adopt penalties to keep the cost of coverage for residents as low as possible.
The ACA established health insurance exchanges, primarily as online marketplaces, administered by either federal or state governments. That’s where individuals, the self-employed, and small businesses can shop and purchase qualified insurance plans and find other options, depending on your income.
How to get affordable health insurance
When you go out on your own, the cost of a health plan can be shocking—especially if you just left a company that paid a big chunk of the insurance bill on your behalf.
Remember that the high cost of health insurance pales when compared to the alternative. Having a medical emergency or being diagnosed with a severe illness that you can’t afford to treat could be devastating.
Remember that the high cost of health insurance pales when compared to the alternative.
Here are six tips for finding affordable health insurance when you become self-employed or no longer have job-based coverage for any reason:
1. Join a spouse or partner’s plan
If your spouse or partner has employer-sponsored health insurance, joining their plan could be your most affordable option. Group insurance generally costs much less than individual coverage. Plus, some employers subsidize a portion of your premium as a benefit.
However, some employer plans may not offer domestic partner benefits to unmarried couples. So, find out from the benefits administrator what’s allowed.
If you’re under age 26, another option is to join or remain on a parent’s health plan if they’re willing to have you. Even if you’re married, not living with your parents, and not financially dependent on them, the ACA allows you to get health insurance using a parent’s plan. However, once you’re over age 26, you’ll have to use another option covered here.
2. Enroll in a federal or state marketplace plan
As I mentioned, the ACA established federal and state marketplaces for consumers who don’t have access to employer-sponsored health insurance. The following states have health insurance exchanges:
- California
- Colorado
- Connecticut
- District of Columbia
- Idaho
- Maryland
- Massachusetts
- Minnesota
- Nevada
- New York
- Rhode Island
- Vermont
- Washington
No matter where you live, you can begin shopping for an ACA-qualified health plan at healthcare.gov. However, you can only apply for a policy during the annual open enrollment period—November 1 to December 15, for coverage that will begin on January 1 of the following year. Some states with healthcare exchanges have an extended enrollment period.
In general, if you miss the enrollment window, you can’t get an ACA health plan until the following year unless you qualify for a special enrollment. That allows you to purchase or change coverage any time of the year if you have a major qualifying life event, such as losing insurance at work, getting married or divorced, having a child, or relocating. However, you typically only have 60 days after the event occurs to enroll.
If your income is too high to qualify for a healthcare subsidy, you can still buy health insurance through the federal or your state’s exchange. You can also get an ACA-qualified health plan directly from an insurance company, a health insurance agent or broker, or an online insurance aggregator.
3. Consider a high-deductible health plan (HDHP)
One way to reduce the cost of health insurance premiums is to choose a high-deductible health plan (HDHP). You enjoy lower monthly premiums but have higher out-of-pocket costs. If you’re in relatively good health, an HDHP can make sense; however, if you get sick, it can end up costing you more.
Paying for a broad range of HSA-eligible medical, dental, mental, and vision costs on a tax-free basis can add up to massive savings!
Another benefit of having an HDHP is that you qualify for a health savings account (HSA). Contributions to an HSA are tax-deductible and can be withdrawn at any time to pay for qualified medical expenses, such as doctor co-pays, prescription drugs, dental care, chiropractic, prescription eyeglasses, and mental health care.
Paying for a broad range of HSA-eligible medical, dental, mental, and vision costs on a tax-free basis can add up to massive savings!
4. Get a short-term plan
If you miss the deadline to enroll in an ACA health plan and don’t qualify for special enrollment, are you simply out of luck? Fortunately, no. You can purchase a short-term health plan until the next enrollment period comes around.
The problem is, short-term plans don’t have to meet ACA standards and only offer temporary coverage, such as for a few months or up to a year. You may be eligible to renew a plan for up to three years in some states, depending on the insurer.
You won’t find short-term plans on the federal or state exchange, and therefore can’t get a subsidy when you purchase one. However, they can be less expensive than an ACA-qualified plan.
Short-term plans can charge more if you have preexisting conditions, put caps on benefits, or not cover essential services like prescriptions and preventive care. Because they fall short of ACA requirements, you can have one and still be subject to a state-mandated health penalty.
You won’t find short-term plans on the federal or state exchange, and therefore can’t get a subsidy when you purchase one. However, they can be less expensive than an ACA-qualified plan.
Having short-term coverage is certainly better than being uninsured, but I recommend replacing it with qualified health coverage as soon as possible. That’s the best way to have the protection you need against the enormous financial risk of medical costs.
5. Enroll in Medicaid and CHIP (Children’s Health Insurance Program)
If you can’t afford health insurance, you may be eligible for free or low-cost coverage through Medicaid or CHIP at any time of year, depending on your income, family size, and the state where you live. In general, if you earn less than the poverty level, which is currently $12,760 for an individual or $26,200 for a family of four, you may qualify for these programs. They may have different names depending on where you live.
Unlike ACA health plans, state-run health programs don’t have set open enrollment periods, so if you qualify, coverage can begin any time of year.
When you complete an application at the federal or state health insurance exchange, you can also determine if you qualify for coverage through Medicaid and CHIP programs. You can learn more about both programs at medicaid.gov.
6. Get COBRA coverage
If you leave a job with group health insurance, you can enroll in COBRA (Consolidated Omnibus Budget Reconciliation Act) coverage. It isn’t an insurance company or a health plan, but a regulation that gives you the option to continue your employer-sponsored health insurance after you’re no longer employed.
Instead of having your plan canceled the month you leave a job, you can use COBRA to continue getting the same benefits and choices you had before you left the company. In most cases, you can get COBRA benefits for up to 18 months.
The problem with COBRA coverage is that it’s temporary and can be expensive. Unlike other federal benefits, such as the Family and Medical Leave Act (FMLA), employers don’t have to pay for COBRA. You typically have to pay the full cost of premiums, plus a 2 percent administrative charge, to the insurer.
If you’re not eligible for regular, federal COBRA, many states offer similar programs, called Mini COBRA. To learn more, check with your state’s department of insurance.
Health insurance shopping tips
After you become self-employed and purchase health insurance, it’s crucial to shop for plans every open enrollment period. Your or your family’s medical needs or income may change.
Additionally, new health insurers come in and go out of the health insurance marketplace. Carriers that offered plans in your ZIP code last year may not be the same set of players this year. In other words, a competitor could offer a similar or better plan than yours, for a lower price. So, if you don’t shop annually, you could leave money on the table.
Source: quickanddirtytips.com
Are Social Security Disability Benefits Taxable?

your financial details.
Social Security benefits, including disability benefits, can help provide a supplemental source of income to people who are eligible to receive them. If you’re receiving disability benefits from Social Security, you might be wondering whether you’ll owe taxes on the money. For most people, the answer is no. But there are some scenarios where you may have to pay taxes on Social Security disability benefits. It may also behoove you to consult with a trusted financial advisor as you navigate the complicated terrain of taxes on Social Security disability benefits.
What Is Social Security Disability?
The Social Security Disability Insurance program (SSDI) pays benefits to eligible people who have become disabled. To be considered eligible for Social Security disability benefits, you have to be “insured”, which means you worked long enough and recently enough to accumulate benefits based on your Social Security taxes paid.
You also have to meet the Social Security Administration’s definition of disabled. To be considered disabled, it would have to be determined that you can no longer do the kind of work you did before you became disabled and that you won’t be able to do any other type of work because of your disability. Your disability must have lasted at least 12 months or be expected to last 12 months.
Social Security disability benefits are different from Supplemental Security Income (SSI) and Social Security retirement benefits. SSI benefits are paid to people who are aged, blind or disabled and have little to no income. These benefits are designed to help meet basic needs for living expenses. Social Security retirement benefits are paid out based on your past earnings, regardless of disability status.
Supplemental Security Income generally isn’t taxed as it’s a needs-based benefit. The people who receive these benefits typically don’t have enough income to require tax reporting. Social Security retirement benefits, on the other hand, can be taxable if you’re working part-time or full-time while receiving benefits.
Is Social Security Disability Taxable?
This is an important question to ask if you receive Social Security disability benefits and the short answer is, it depends. For the majority of people, these benefits are not taxable. But your Social Security disability benefits may be taxable if you’re also receiving income from another source or your spouse is receiving income.
The good news is, there are thresholds you have to reach before your Social Security disability benefits become taxable.
When Is Social Security Disability Taxable?
The IRS says that Social Security disability benefits may be taxable if one-half of your benefits, plus all your other income, is greater than a certain amount which is based on your tax filing status. Even if you’re not working at all because of a disability, other income you’d have to report includes unearned income such as tax-exempt interest and dividends.
If you’re married and file a joint return, you also have to include your spouse’s income to determine whether any part of your Social Security disability benefits are taxable. This true even if your spouse isn’t receiving any benefits from Social Security.
The IRS sets the threshold for taxing Social Security disability benefits at the following limits:
- $25,000 if you’re single, head of household, or qualifying widow(er),
- $25,000 if you’re married filing separately and lived apart from your spouse for the entire year,
- $32,000 if you’re married filing jointly,
- $0 if you’re married filing separately and lived with your spouse at any time during the tax year.
This means that if you’re married and file a joint return, you can report a combined income of up to $32,000 before you’d have to pay taxes on Social Security disability benefits. There are two different tax rates the IRS can apply, based on how much income you report and your filing status.
If you’re single and file an individual return, you’d pay taxes on:
- Up to 50% of your benefits if your income is between $25,000 and $34,000
- Up to 85% of your benefits if your income is more than $34,000
If you’re married and file a joint return, you’d pay taxes on:
- Up to 50% of your benefits if your combined income is between $32,000 and $44,000
- Up to 85% of your benefits if your combined income is more than $44,000
In other words, the more income you have individually or as a married couple, the more likely you are to have to pay taxes on Social Security disability benefits. In terms of the actual tax rate that’s applied to these benefits, the IRS uses your marginal tax rate. So you wouldn’t be paying a 50% or 85% tax rate; instead, you’d pay your ordinary income tax rate based on whatever tax bracket you land in.
It’s also important to note that you could be temporarily pushed into a higher tax bracket if you receive Social Security disability back payments. These back payments can be paid to you in a lump sum to cover periods where you were disabled but were still waiting for your benefits application to be approved. The good news is you can apply some of those benefits to past years’ tax returns retroactively to spread out your tax liability. You’d need to file an amended return to do so.
Is Social Security Disability Taxable at the State Level?
Besides owing federal income taxes on Social Security disability benefits, it’s possible that you could owe state taxes as well. As of 2020, 12 states imposed some form of taxation on Social Security disability benefits, though they each apply the tax differently.
Nebraska and Utah, for example, follow federal government taxation rules. But other states allow for certain exemptions or exclusions and at least one state, West Virginia, plans to phase out Social Security benefits taxation by 2022. If you’re concerned about how much you might have to pay in state taxes on Social Security benefits, it can help to read up on the taxation rules for where you live.
How to Report Taxes on Social Security Disability Benefits
If you received Social Security disability benefits, those are reported in Box 5 of Form SSA-1099, Social Security Benefit Statement. This is mailed out to you each year by the Social Security Administration.
You report the amount listed in Box 5 on that form on line 5a of your Form 1040 or Form 1040-SR, depending on which one you file. The taxable part of your Social Security disability benefits is reported on line 5b of either form.
The Bottom Line
Social Security disability benefits aren’t automatically taxable, but you may owe taxes on them if you pass the income thresholds. If you’re worried about how receiving disability benefits while reporting other income might affect your tax bill, talking to a tax professional can help. They may be able to come up with strategies or solutions to minimize the amount of taxes you’ll end up owing.
Tips on Taxes
- Consider talking to a financial advisor as well about how to make the most of your Social Security disability benefits and other income. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help. By answering a few simple questions you can get personalized recommendations for professional advisors in your local area in minutes. If you’re ready, get started now.
- While you don’t have to reach a specific age to apply for Social Security disability benefits or Supplemental Security Income benefits, there is a minimum age for claiming Social Security retirement benefits. A Social Security calculator can help you decide when you should retire.
Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/JannHuizenga, ©iStock.com/AndreyPopov
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7 Pros and Cons of Investing in a 401(k) Retirement Plan at Work
Should you always use a 401(k) at work if you have one? Laura reviews the main advantages and disadvantages of workplace retirement plans. You’ll learn some lesser-known benefits and tips to make sure you’ll have plenty of money when you’re ready to kick back and enjoy retirement.
solo 401(k). These accounts allow you to contribute a portion of your paycheck or self-employment income and choose various savings and investment options such as CDs, stock funds, bond funds, and money market funds, to accelerate your account growth.
Traditional retirement accounts give you an immediate benefit by making contributions on a pre-tax basis, which reduces your annual taxable income and your tax liability. You defer paying income tax on contributions and account earnings until you take withdrawals in the future.
Roth retirement accounts require you to pay tax upfront on your contributions. However, your future withdrawals of contributions and investment earnings are entirely tax-free. A Roth 401(k) or 403(b) is similar to a Roth IRA; however, unlike a Roth IRA there isn’t an income limit to qualify. That means even high earners can participate in a Roth at work and reap the benefits.
RELATED: How the COVID-19 CARES Act Affects Your Retirement
Pros of investing in a 401(k) retirement plan at work
When I was in my 20s and started my first job that offered a 401(k), I didn’t enroll in it. I was nervous about having investments with an employer because I didn’t understand what would happen if I left the company, or it went out of business.
I want to put your mind at ease about using a 401(k) because there are many more advantages than disadvantages.
I want to put your mind at ease about using a 401(k) because there are many more advantages than disadvantages. Here are four primary pros for using a retirement plan at work.
1. Having federal legal protection
Qualified workplace retirement plans are protected by the Employee Retirement Income Security Act of 1974 (ERISA), a federal law. It sets minimum standards for employers that offer retirement plans, and the administrators who manage them.
ERISA offers workplace retirement plans a powerful but lesser-known benefit—protection from creditors.
ERISA was enacted to protect your and your beneficiaries’ interests in workplace retirement plans. Here are some of the protections they give you:
- Disclosure of important facts about your plan features and funding
- A claims and appeals process to get your benefits from a plan
- Right to sue for benefits and breaches of fiduciary duty if the plan is mismanaged
- Payment of certain benefits if you lose your job or a plan gets terminated
Additionally, ERISA offers workplace retirement plans a powerful but lesser-known benefit—protection from creditors. Let’s say you have money in a qualified account but lose your job and can’t pay your car loan. If the car lender gets a judgment against you, they can attempt to get repayment from you in various ways, but not by tapping your 401(k) or 403(b). There are exceptions when an ERISA plan is at risk, such as when you owe federal tax debts, criminal penalties, or an ex-spouse under a Qualified Domestic Relations Order.
When you leave an employer, you have the option to take your vested retirement funds with you. You can do a tax-free rollover to a new employer’s retirement plan or into your own IRA. However, be aware that depending on your home state, assets in an IRA may not have the same legal protections as a workplace plan.
RELATED: 5 Options for Your Retirement Account When Leaving a Job
2. Getting matching funds
Many employers that offer a retirement plan also pay matching contributions. Those are additional funds that boost your account value.
Always set your 401(k) contributions to maximize an employer’s match so you never leave easy money on the table.
For example, your company might match 100% of what you contribute to your retirement plan up to 3% of your income. If you earn $50,000 per year and contribute 3% or $1,500, your employer would also contribute $1,500 on your behalf. You’d have $3,000 in total contributions and receive a 100% return on your $1,500 investment, which is fantastic!
Always set your 401(k) contributions to maximize an employer’s match, so you never leave easy money on the table.
3. Having a high annual contribution limit
Once you contribute enough to take advantage of any 401(k) matching, consider setting your sights higher by raising your savings rate every year. For 2021, the allowable limit remains $19,500, or $26,000 if you’re over age 50. A good rule of thumb is to save at least 10% to 15% of your gross income for retirement.
Most retirement plans have an automatic escalation feature that kicks up your contribution percentage at the beginning of each year. You might set it to increase your contributions by 1% per year until you reach 15%. That’s a simple way to set yourself up for a happy and secure retirement.
4. Getting free investing advice
After you enroll in a workplace retirement plan, you must choose from a menu of savings and investment options. Most plan providers are major brokerages (such as Fidelity or Vanguard) and have helpful resources, such as online assessments and free advisors. Take advantage of the opportunity to get customized advice for choosing the best investments for your financial situation, age, and risk tolerance.
In general, the more time you have until retirement, or the higher your risk tolerance, the more stock funds you should own. Likewise, having less time or a low tolerance for risk means you should own more conservative and stable investments, such as bonds or money market funds.
RELATED: A Beginner’s Guide to Investing in Stocks
Cons of investing in a 401(k) retirement plan at work
While there are terrific advantages of investing in a retirement plan at work, here are three cons to consider.
1. You may have limited investment options
Compared to other types of retirement accounts, such as an IRA, or a taxable brokerage account, your 401(k) or 403 (b) may have fewer investment options. You won’t find any exotic choices, just basic asset classes, including stock, bond, and cash funds.
However, having a limited investment menu streamlines your investment choices and minimizes complexity.
2. You may have higher account fees
Due to the administrative responsibilities required by employer-sponsored retirement plans, they may charge high fees. And as a plan participant, you have little control over the fees you must pay.
One way to keep your workplace retirement account fees as low as possible is selecting low-cost index funds or exchange-traded funds (ETFs) when possible.
One way to keep your workplace retirement account fees as low as possible is selecting low-cost index funds or exchange-traded funds (ETFs) when possible.
3. You must pay fees on early withdrawals
One of the inherent disadvantages of putting money in a retirement account is that you’re typically penalized 10% for early withdrawals before the official retirement age of 59½. Plus, you typically can’t tap a 401(k) or 403(b) unless you have a qualifying hardship. That discourages participants from tapping accounts, so they keep growing.
The takeaway is that you should only contribute funds to a retirement account that you won’t need for everyday living expenses. If you avoid expensive early withdrawals, the advantages of using a workplace retirement account far outweigh the downsides.
Source: quickanddirtytips.com
How to Avoid Paying Taxes on Inherited Property

your financial details.
Inheriting a home or other property can increase the value of your estate but it can also result in tax consequences. If the property you inherit has appreciated in value since the original owner purchased it, you could be on the hook for capital gains tax should you choose to sell it. That could result in a large tax bill if there’s a sizable gap between the original purchase price and the price you’re able to sell the property for. There are some possibilities for how to avoid paying capital gains tax on inherited property which are worth considering if you’re the beneficiary of an estate or trust
Capital Gains Tax, Explained
Capital gains tax applies when an investment is sold for more than its original purchase price. Typically, you might think about capital gains tax in terms of selling stocks or other securities you hold inside your investment portfolio. So if you bought a stock for $2 per share and sold it for $5 per share, you’d owe capital gains on the $3 in profit you realized from the sale.
The IRS taxes capital gains differently, depending on how long you hold the underlying asset. The short-term capital gains tax rate applies to investments or assets you hold for less than one year. The long-term capital gains tax rate applies to investments or assets you hold longer than one year.
Between the two, the long-term capital gains tax rate is more favorable. Short-term capital gains are taxed at your ordinary income tax rate, whereas long-term capital gains are taxed at 0%, 15% or 20% tax rates, based on your filing status and taxable income for the year. So if you’re in a higher tax bracket, it typically makes more sense to hold investments longer to minimize the amount of capital gains tax you owe.
Capital Gains Tax Rules for Inherited Property
When inheriting property, such as a home or other real estate, the capital gains tax kicks in if you sell that asset at a higher price point than the person you inherited it from paid for it. Likewise, it’s possible to claim a capital loss deduction if you end up selling the property at a loss.
The difference with inherited property, however, is that the IRS allows you to use what’s known as a stepped-up basis for calculating capital gains tax liability. The step-up cost basis represents the value of the home when you inherit it versus its original purchase price.
For example, say your parents bought a home for $100,000 that’s worth $400,000 by the time you inherit it. Under ordinary capital gains tax rules, you’d owe tax on the $300,000 difference between what your parents paid for it and its current value.
That could result in a huge tax bill for you, which is why the IRS allows you to use the stepped-up basis instead. Assume that you don’t sell the home right away, for instance. You hold on to the property for two years, at which time you sell it for $450,000. Taking the step-up basis of $400,000 into account, you’d only pay capital gains on tax on the $50,000 in appreciation value.
That wouldn’t allow you to completely avoid paying capital gains taxes on inherited property, but using the step-up cost basis can reduce the amount of capital gains tax you’d owe.
How to Avoid Paying Capital Gains Tax On Inherited Property
If you stand to inherit property and you want to avoid paying taxes on it, there are three possible options for minimizing or eliminating capital gains tax altogether. The first is to simply sell the property as soon as you inherit it. By selling it right away, you aren’t leaving any room for the property to appreciate in value any further. So if you inherit your parents’ home and it’s worth $250,000, selling it right away could help you avoid capital gains tax if it’s still only worth $250,000 at the time of the sale.
That may not be ideal, however, if it was your parents’ wish or your desire to keep the home in the family. In that scenario, there’s a second option you can consider.
Instead of selling the home right away, you could move into it and make it your primary residence. You could then sell the home two years later, potentially excluding some or all of the capital gains from the sale.
The IRS allows single filers to exclude up to $250,000 in capital gains from the sale of a home, increasing that to $500,000 for married couples filing a joint return. The key is that you have to live in the home for at least two of the five years preceding the sale. So if you can envision yourself living in your parents’ home for at least two years, this is another way you might be able to avoid paying capital gains tax on the property.
A third option is to not sell the property and rent it out instead of living in it. This can be a little tricky, however, since there are still tax rules you have to observe. An inherited home that’s treated as an investment property for tax purposes would still be subject to capital gains tax if you decide to sell it. But you could defer paying those taxes if you complete a 1031 exchange to purchase another investment property to replace the one you’re selling.
Disclaiming an Inheritance to Avoid Capital Gains Tax
There’s one more possibility for how to avoid paying capital gains tax on inherited property. That’s simply choosing not to inherit it at all.
This is called disclaiming an inheritance and it’s something you can choose to do if you’d prefer not to get entangled in tax issues related to someone else’s estate. The downside, of course, is that once you formally disclaim an inheritance, you can’t go back and change your mind. Whatever property you forfeited would be passed on to the next person in line to inherit.
The Bottom Line
Inheriting property can trigger capital gains tax if you choose to sell it. And there are other taxes you may need to consider, such as state inheritance taxes. If the inherited property is a residence consider living in it for a few years before selling it. Alternatively, consider renting it. Talking to an estate planning attorney or a tax professional may be helpful if you stand to inherit assets from your parents or anyone else and you’re worried about owing Uncle Sam.
Tips for Estate Planning
- Consider talking to a financial advisor about what you should be including in your own estate plan. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help you connect with professional advisors in your local area in minutes. If you’re ready, get started now.
- Property taxes in America are collected by local governments as well as the federal government. The money collected is generally used to support community safety, schools, infrastructure and other public projects. A property tax calculator can help you better understand the average cost of property taxes in your state and county.
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Should You Transfer Balances to No-Interest Credit Cards Multiple Times?
Considering a no-interest balance transfer offer? Laura talks about the pros and cons of balance transfers and whether moving debt multiple times can help or hurt you.
balance transfer credit card is also known as a no-interest or zero-interest credit card. It’s a card feature that includes an offer for you to transfer balances from other accounts and save money for a limited period.
You typically pay an annual percentage rate (APR) of 0% during a promotional period ranging from 6 to 18 months. In general, you’ll need good credit to qualify for the best transfer deals.
Every transfer offer is different because it depends on the issuer and your financial situation; however, the longer the promotional period, the better. You don’t accrue one penny of interest until the promotion expires.
However, you typically must pay a one-time transfer fee in the range of 2% to 5%. For example, if you transfer $1,000 to a card with a 2% transfer fee, you’ll be charged $20, which increases your debt to $1,020. So, choose a transfer card with the lowest transfer fee and no annual fee, when possible.
When you get approved for a new balance transfer card, you get a credit limit, just like you do with other credit cards. You can only transfer amounts up to that limit.
Missing a payment means your sweet 0% APR could end and that you could get charged a default APR as high as 29.99%!
You can use a transfer card for just about any type of debt, such as credit cards, auto loans, and personal loans. The issuer may give you the option to have funds deposited into your bank account so that you can send it to the creditor of your choice. Or you might be asked to complete an online form indicating who to pay, the account number, and the amount so that the transfer card company can pay it on your behalf.
Once the transfer is complete, the debt balance moves over to your transfer card account, and any transfer fee gets added. But even though no interest accrues to your account, you must still make monthly minimum payments throughout the promotional period.
Missing a payment means your sweet 0% APR could end and that you could get charged a default APR as high as 29.99%! That could easily wipe out any benefits you hoped to gain by doing a balance transfer in the first place.
How does a balance transfer affect your credit?
A common question about balance transfers is how they affect your credit. One of the most significant factors in your credit scores is your credit utilization ratio. It’s the amount of debt you owe on revolving accounts (such as credit cards and lines of credit) compared to your available credit limits.
For example, if you have $2,000 on a credit card and $8,000 in available credit, you’re using one-quarter of your limit and have a 25% credit utilization ratio. This ratio gets calculated for each of your revolving accounts and as a total on all of them.
Getting a new balance transfer credit card (or an additional limit on an existing card) instantly raises your available credit, while your debt level remains the same. That causes your credit utilization ratio to plummet, boosting your scores.
I recommend using no more than 20% of your available credit to build or maintain optimal credit scores. Having a low utilization shows that you can use credit responsibly without maxing out your accounts.
Getting a new balance transfer credit card (or an additional limit on an existing card) instantly raises your available credit, while your debt level remains the same. That causes your credit utilization ratio to plummet, boosting your scores.
Likewise, the opposite is true when you close a credit card or a line of credit. So, if you transfer a card balance and close the old account, it reduces your available credit, which spikes your utilization ratio and causes your credit scores to drop.
Only cancel a paid-off card if you’re prepared to see your credit scores take a dip.
So, only cancel a paid-off card if you’re prepared to see your scores take a dip. A better decision may be to file away a card or use it sparingly for purchases you pay off in full each month.
Another factor that plays a small role in your credit scores is the number of recent inquiries for new credit. Applying for a new transfer card typically causes a slight, short-term dip in your credit. Having a temporary ding on your credit usually isn’t a problem, unless you have plans to finance a big purchase, such as a house or car, within the next six months.
The takeaway is that if you don’t close a credit card after transferring a balance to a new account, and you don’t apply for other new credit accounts around the same time, the net effect should raise your credit scores, not hurt them.
RELATED: When to Cancel a Credit Card? 10 Dos and Don’ts to Follow
When is using a balance transfer credit card a good idea?
I’ve done many zero-interest balance transfers because they save money when used correctly. It’s a good strategy if you can pay off the balance before the offer’s expiration date.
Let’s say you’re having a good year and expect to receive a bonus within a few months that you can use to pay off a credit card balance. Instead of waiting for the bonus to hit your bank account, you could use a no-interest transfer card. That will cut the amount of interest you must pay during the card’s promotional period.
When should you do multiple balance transfers?
But what if you’re like Heather and won’t pay off a no-interest promotional offer before it ends? Carrying a balance after the promotion means your interest rate goes back up to the standard rate, which could be higher than what you paid before the transfer. So, doing another transfer to defer interest for an additional promotional period can make sense.
If you make a second or third balance transfer but aren’t making any progress toward paying down your debt, it can become a shell game.
However, it may only be possible if you’re like Heather and have good credit to qualify. Balance transfer cards and promotions are typically only offered to consumers with good or excellent credit.
If you make a second or third balance transfer but aren’t making any progress toward paying down your debt, it can become a shell game. And don’t forget about the transfer fee you typically must pay that gets added to your outstanding balance. While avoiding interest is a good move, creating a solid plan to pay down your debt is even better.
If you have a goal to pay off your card balance and find reasonable transfer offers, there’s no harm in using a balance transfer to cut interest while you regroup.
Advantages of doing a balance transfer
Here are several advantages of using a balance transfer credit card.
- Reducing your interest. That’s the point of transferring debt, so you save money for a limited period, even after paying a transfer fee.
- Paying off debt faster. If you put the extra savings from doing a transfer toward your balance, you can eliminate it more quickly.
- Boosting your credit. This is a nice side effect if you open a new balance transfer card and instantly have more available credit in your name, which lowers your credit utilization ratio.
Disadvantages of doing a balance transfer
Here are some cons for doing a balance transfer.
- Paying a fee. It’s standard with most cards, which charge in the range of 2% to 5% per transfer.
- Paying higher interest. When the promotion ends, your rate will vary by issuer and your financial situation, but it could spike dramatically.
- Giving up student loan benefits. This is a downside if you’re considering using a transfer card to pay off federal student loans that come with repayment or forgiveness options. Once the debt gets transferred to a credit card, the loan benefits, including a tax deduction on interest, no longer apply.
Tips for using a balance transfer credit card wisely
The best way to use a balance transfer is to have a realistic plan to pay off the balance before the promotion expires.
The best way to use a balance transfer is to have a realistic plan to pay off the balance before the promotion expires. Or be sure that the interest rate will be reasonable after the promotion ends.
Shifting a high-interest debt to a no-interest transfer account is a smart way to save money. It doesn’t make your debt disappear, but it does make it less expensive for a period.
If you can save money during the promotional period, despite any balance transfer fees, you’ll come out ahead. And if you plow your savings back into your balance, instead of spending it, you’ll get out of debt faster than you thought possible.
Source: quickanddirtytips.com