The single most important piece of advice I ever received
I was 24 and had a very good job as a software engineer earning roughly $100K a year in salary and bonus. This had been more money than I had ever earned in my life and more than I had ever dreamed of growing up poor.
My girlfriend and I (now my wife) decided we needed some financial advice and so we visited our local Citibank to talk to someone there about an IRA or CDs. Honestly, I can’t really remember the questions I asked, I was so new and unfamiliar with it all. I remember the gentleman asking me if I was contributing to a 401K at work, to which I said “no”.
At that point, he was no longer interested in really exploring options with me. He told me to contribute to the 401K and come back when I had done so. He gave us a little souvenir in the form of a pin for our visit and saw us out. I thought it was odd that he didn’t try to sell us any services past that point. I guess he saw we were not ready for what he had available. We hadn’t even covered the basics in his mind.
Fast forward 5 years, and unfortunately I did not follow through on his advice. Having been married in 2009, my wife and I stacked cash in a savings account when we had extra money and anything we didn’t immediately need into a taxable investing account. Interest rates had been great the last few years, somewhere in the neighborhood of 4% so I thought we were doing great.
Our combined income was growing rapidly, even with two kids and a mortgage, we had money left over for savings and investing. Sometime after 2010 we had a very sizable federal tax bill. Apparently I didn’t adjust our withholdings to match our increasing incomes. We owned the IRS more than $15,000 and the state roughly $2,000.
We luckily had the cash on hand but that was a huge, unwelcome surprise. Owing that much money in taxes left me feeling very ignorant. I went on a bing figuring out what I could have done differently and how I could lower my tax bill.
What did I learn? Lots of things, but the most important!? I should have put money into my company's 401K!
First, it would have reduced my tax bill. Here’s a table of how that would have worked out, assuming a combined income of $175,000. Using 2012’s tax brackets, here’s the federal taxes we had paid. This does not include other deductions to keep things simple.
2020 Federal Tax Brackets - Married Filing Jointly (source)
| Taxable Income | Tax Rate | Taxes Paid |
|---|---|---|
| $0 – $17,400 | 10% | 10% of the amount over $0 |
| $17,401-$70,700 | 15% | $1,740 plus 15% of the amount over $17,400 |
| $70,700 – $142,700 | 25% | $9,735 plus 25% of the amount over $70,700 |
| $142,700 – $217,450 | 28% | $27,735 plus 28% of the amount over $142,700 |
| $217,450 – $388,350 | 33% | $48,665 plus 33% of the amount over $217,450 |
| $388,350 - No Limit | 35% | $105,062 plus 35% of the amount over $388,350 |
With a taxable income of $175,000 and no 401K contributions, we paid $27,735 plus 28% of anything over $142,700, which came out to be $9,044, for a total of $36,779.
Had we contributed to my 401K with the maximum contribution limit of $17,000 for 2012, our taxable income goes down to ($175,000 - $17,000 = $158,000). With this new value we would have paid $32,019!
That’s a tax savings of $4,760!
That’s close to $5,000 that we would have kept instead of paid the IRS. If we had both contributed to our 401K, we would have owned $27,310 in federal taxes and essentially saved $9,469 when compared to not contributing at all.
This opened my eyes on how understanding money and taxes had a very real financial impact for my family. If we had done this early or even that year, we would have put $34,000 towards retirement and saved $9,469 on our tax bill.
Many of you may think this is just the basics, but for me at that time, it was an eye opener. From that point on, I formed a big interest in personal finance and taxes that has helped me become a financial secure today.
Bottom line, start somewhere, start small, once you see the impact, you’ll be hooked like me. You’ll enjoy knowing that you saved money and that it’s growing year by year.