Here is my latest story for my friends Scott and Dan over at 403bwise. Teachers have some amazing ways to save on their taxes. Unfortunately, their biggest tax shelter, their 403(b) plan, is often riddled with high-cost products sold by conflicted financial salespeople. Imagine a world where teachers could lower their taxes and also have an awesome suite of low-cost investment choices.
We are working hard right now with our partners to make this dream a reality. If you know a teacher, please pass this on. It could literally be the biggest financial favor you could do for your teacher friends and their families. Please read on to get the full story.
403(b) Story: Tax Planning for Teachers
by Tony Isola, CFP
Teachers have excellent opportunities to save significant money when filing their taxes.
Instead of looking at tax season with dread, take advantage of some of the unique tax saving opportunities available for educators.
UNIQUE TAX SAVING OPPORTUNITIES
Teachers need to take advantage of unique opportunities regarding both their 457(b) and 403(b) retirement plans. We are aware that only about 30% of K-12 teachers participate in their retirement plans due to poor investment options. This should not stand in the way of the massive tax shelter that is available to you.
Aspire offers many low cost options. They are a ray of sunlight in the dark jungle of unnecessary variable annuities and high-cost mutual funds sold by conflicted financial salespeople.
Aspire is in thousands of districts nationwide. If your district does not include options like Fidelity or Vanguard, demand that Aspire be added to your platform. If you need some help, let us know!
Once you are sure you have some good investment options available, now is the time to save some serious money on your taxes.
Every dollar you contribute to your 403(b) Plan is considered an “above the line” deduction. What this simply means is these paycheck contributions are reducing your taxes on a dollar-for-dollar basis.
Say, for example, you earn $50,000 a year. If you contribute 10% or $5,000 to your 403(b) plan, the amount that will be reported as income to the I.R.S. will be $45,000.
The best part about this is if you did not contribute the $5,000, you would not see that amount in your paycheck because of taxes anyway.
For example, a teacher at this income level in NY State would probably see only about $3,400 after taxes. In effect you are buying $5,000 for $3,400 by contributing to your retirement plan. This is a deal even Warren Buffet would find impressive!
This does not include the immense benefits of compound interest on your investments. Eventually you will have to pay taxes on these funds; the good news is that is not until you reach age 70.5. At that time you might be in a lower tax bracket and you only have to take out the government required minimum, called a Required Minimum Distribution.
If your 403(b) plans choices are atrocious, and your insensitive administration refuses to change it, teachers still have other tax-saving options.
INDIVIDUAL RETIREMENT ACCOUNT OPTIONS
Educators can contribute to a traditional IRA and, if they are below certain income levels, may be eligible for an above the line deduction of $5,500 (or $6,500 if above age 50.) Or, if their income levels permit, teachers can instead contribute these amounts to a Roth IRA, on an after-tax basis. This means the contribution will not reduce current income. The benefit comes later, in the form of tax-free withdrawals during retirement. The problem here is the maximum contribution amounts for traditional and Roth IRAs are much less than the sums that can go toward a 403(b) or 457(b) plan.
For 2017 the contribution limits are $18,000 ($24,000 for those age 50 or older). If teachers have access to both a 457(b) and 403(b) plan, they are eligible to contribute the maximum to both. This is a great and unique way to save money on taxes for super-saving teachers out there!
Many teachers say they have pensions or they cannot afford to make contributions based on their living expenses.
It turns out in this example that the cost for a $5,000 annual contribution, after taxes, comes to about $287 out of your monthly paycheck. This works out to about $9 a day! Many teachers spend more than this on their daily trips to Starbucks. You can afford it if you look closely at your budget and honestly assess your spending using a wants vs. needs set of criteria.
EDUCATOR EXPENSE DEDUCTION
Next, all teachers are entitled to the educator expense deduction. Any school-related expenses that are not reimbursed are eligible for this deduction. A single teacher is entitled to $250, while two married teachers will receive a $500 benefit. This is also an above the line deduction, which reduces taxes dollar for dollar.
Like the 403(b) deduction, these benefits are available to you even if you do not itemize your taxes. Many young teachers are in this category since they may not yet own a home or have children.
If you itemize your taxes and spend over 2% over your adjusted gross income, you may also write off this additional amount. These expenses could include job-related items such as computer software, conferences, mileage, and other materials spent on/relating to your classroom. Check with your accountant to make the most of all of these teacher benefits.
Teachers and others may deduct student loan interest. This above the line deduction will have an immediate effect on reducing taxable income. Many teachers have hefty amounts of student debt. This is a way to relieve some of this burden and put more money in your pocket to save for your retirement or pay down debt.
Many young teachers are still in school. In order to attain permanent certification in most states, teachers must earn a master’s degree. Some teachers would like to attain certification in an additional subject or move into administration. This requires tuition money.
There are many breaks available for teachers taking college courses. These include, The Education Tax Credit, American Opportunity Credit, or the Lifetime Learning Credit
Dave Grant has a great article here to explain this in more depth.
These choices can be somewhat complicated and have income levels for eligibility. It would be a good idea to check with your accountant to help you decide which benefit will give you the most bang for your buck. The most important thing is to be aware that these benefits exist.
Finally, for those teachers with younger children, some tax relief may be found by contributing to their 529 college plans.
In my state of NY, married couples can deduct up to $10,000 off their state income taxes if they match this amount in yearly college contributions. Single parents are eligible for a $5,000 NY state tax write off.
Make sure to check the benefits your individual state may offer regarding their 529 college saving program. You just might uncover a hidden tax gem as a reward for responsibly saving for your children’s future.
While taxes are an unpleasant part of living in a democracy that cares for those less fortunate, there is a bright side to this topic. While short-term investment returns are beyond anyone’s control, taxes are something that teachers and others have some degree of control over.
Using proper tax planning by taking advantage of large legal tax shelters like a 403(b) plan and other items mentioned here can have a dramatic effect on your life.
This can mean the difference between having to work several additional years and enduring a disappointing standard of living during retirement.
Save for your future and lower your taxes. There are few better ways to grow long-term wealth.