How taking tax deductions actually costs you money
: Some people don’t carefully compare traditional and Roth IRAs. Contributing retirement funds to a traditional IRA provides an immediate deduction, but choosing a non-deductible Roth IRA and paying some taxes could make more sense.
For example, a young married couple with a taxable income of $19,900 is in the 10% tax bracket. With a good chance their income at retirement will be considerably higher, saving 10% in taxes today could mean paying 12%, 15% or even 37% when those funds are withdrawn. With a Roth IRA, this couple would pay 10% taxes on their contribution today in exchange for paying zero taxes on their future withdrawals.It often makes financial sense to convert a portion or all of traditional IRAs to Roth IRAs.
Here's why. The current average interest rate on high-quality 10-year municipal bonds is 1.1%. The average interest rate on high-quality 10-year corporate bonds is 2.1%. Even if you are in the highest federal tax bracket, owning the taxable corporate bond would net you 1.32%, which is still higher than the municipal bond. It’s important to do the math before investing in tax-free municipal bonds.
Spending a dollar just to save any portion of it in taxes only reduces your net worth. Such behavior is not in your best financial interest, even though it is completely rational based on the beliefs and emotions behind it. Those beliefs might include distrust of government, a desire to punish or control government by reducing its revenue, inaccurate assumptions as to how tax brackets work and a belief that paying less in taxes is always the best choice.
Tax deductions only make sense if you actually need or want to spend money for deductible items like property taxes, interest, charitable giving or necessary business expenses. Reducing taxes by overvaluing deductions only reduces your own financial well-being.
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