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 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 are making $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 N.Y. 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 it 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 tax saving options.
Educators can contribute to a traditional IRA and if they are below certain income levels be eligible for an above the line deduction of $5,500 or $6,500 if above age 50.. Teachers can also contribute these amounts to a Roth IRA on an after tax basis. This means your contribution will not reduce your current income. You will receive this later with tax free withdrawals during retirement.
The problem here is the amounts you can contribute to traditional and Roth IRA’s are much less than the sums that can go toward a 403(b) or 457 plan.
For 2017 the limits are $18,000 and $24,000 for those above 50 in these plans. If teachers have access to both a 457 and 403(b) plan, they are eligible to contribute the maximum to both. Talk about a great and unique way to save money on your 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 were accounted for 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 your 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 you spent on your 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 couple 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 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 your or anyone’s control, taxes are something that teacher’s 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 their 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.