Making the most of your tax cut
By James Nelson
Sunday, May 6, 2018
On December 22, 2017 President Trump signed into law arguably the most significant reforms to our tax code in the past 30 years.
While the majority of the law focused on stimulating economic growth through changes to the corporate tax code, there are tax cuts in the law for you and me as well. Determining how much you will save in taxes is another matter.
Given the complexity of our tax code, estimating the amount of tax relief for the “average” family is difficult to do and is highly dependent upon the assumptions made about the family’s income and deductions.
Speaker of the House, Paul Ryan, has suggested that a hypothetical family of four, earning the median family income, would pay $1,602 less in federal income taxes each year. This translates to an increase in after-tax income of roughly $133 per month.
The Tax Foundation, however, estimated in a recent study that the average middle-class family in North Carolina would only see their after-tax income increase by $591.40 per year, or about $50 per month. Regardless of whose estimates are correct, the question is what are you going to do with your new-found after-tax income? Let me offer a few suggestions.
Suggestion 1: Pay down your credit card debt. According to the Federal Reserve Bank of New York, the average North Carolinian household has over $8,000 in credit card debt. And with the national average interest rate across all types of credit cards coming in at almost 16 percent APR, this translates into almost $1,400 yearly in credit card interest per household.
If you were to use your newly found $50 per month to pay down this debt, you could save almost $500 in interest over the next three years. If you continued this strategy you could save over $1,500 over the next five years and almost $3,500 over seven years. Unbelievable? No, it is the power of compound interest.
Suggestion 2: Start an emergency fund. As a rule of thumb, many financial advisors recommend putting aside enough cash to cover three to six months’ worth of expenses. The latest financial security index survey by Bankrate, however, revealed that only 39 percent of respondents had enough savings to cover even a $1,000 unexpected expense.
The same survey showed that 34 percent of American households experienced a major unexpected expense over the previous year. So, prepare for the unexpected and consider having your new found $50 transferred automatically each month into a savings account to build up your own emergency fund.
Suggestion 3: Invest in a Roth IRA. Because of congressional budget rules, the individual tax cuts will expire in 10 years if not renewed. But what if, for the next 10 years, you were to invest your tax savings into a Roth IRA account?
Using the last 10 years of returns on the S&P500 index as a guide, if you invest just $50 per month into a S&P500 index fund you would have an additional $8,200 saved for retirement in 10 years. Even if your monthly deposits stop after 10 years, your money should continue to grow tax-free in your IRA account. Assuming a conservative 6 percent annual return for the foreseeable future, your account would be worth approximately $15,000 in 20 years, $27,00 in 30 years, and $50,000 in 40 years.
Obviously, the market offers no guaranteed return so these are only projections and regardless of whether or not you follow any of these suggestions, I hope your new found tax savings will add to your financial health .
James Nelson is on faculty in the College of Business at ECU.