The often-dreaded tax day is just around the corner. But, as this day approaches, whether we’re anticipating it or not, it provides the perfect opportunity for us, as parents, to teach our teens about taxes, and, if they’ve had a part-time job, filing a tax return.
As our children move toward adulthood, they face many milestones. And with these milestones come great opportunities for them to learn important life skills.
The subject of income taxes and income tax filing, like most financial concepts, is not taught in school. Most teen’s initial understanding of taxes and tax filing is limited to the look of anguish they see on their parents’ faces during tax season.
A teen job is likely your child’s first, and no doubt shocking, introduction to the world of taxes. When they receive their first paycheck, they will notice that some of their money has been taken from this vaguely familiar entity called the federal government, and in some cases the state and city governments as well. (The FICA tax is separate discussion.)
Most teens have trouble understanding the tax concept (some adults still do). It seems strange, as well as frustrating, that some of their hard-earned money was deducted for such shared services as government employee benefits, roads and national defense. All they really comprehend at this point in their young, working lives is that these items have affected their cash in hand.
As parents, we can help our teenagers better understand income taxes by explaining the following:
1. Make them aware that when they work and earn money, they have to pay taxes – Explain that when they receive money from a company, the company will take taxes out of their pay and, if they make over a certain amount in a given year (with no unearned income, above $6,300), they will be required to file a separate tax return. (In most cases, a 1040EZ.)
Teens should also understand that even though they may not be required to file a tax return, it might be beneficial for them to do so anyway. If, for example, they’ve worked part-time for an employer, earning less then the required amount, and federal taxes were taken out on that lesser amount, they’ll be due a refund. The only way they can receive this refund is by filing an income tax form.
2. Teens should also become familiar with certain tax forms and paperwork – Explain and help them fill out their W-4 when they land their first job, and how it affects their net income. When they receive their first W-2, go over it with them (even the boxes that don’t pertain to them), and how this form is used to file their tax return. Explain the importance of the form and that it should be kept in a safe place.
3. Teach your teen how to file their own tax return – Now is an ideal time to show them how to file their return because, in most cases, their tax situations are extremely simple.
Many tax preparation software companies, like TurboTax for example, offer free e-filing if certain qualifications are met. (Visit IRS.gov for details and lists of free software options.)
These programs will walk your teen through the process, step-by-step, and keep them updated on the progress of their return. If your teen doesn’t have a checking account already, now is a good time to open one. (Their return can be automatically deposited in their account.) By helping them with this the first time, they’ll soon become old pros.
The bottom line is that it is up to us to teach our children about taxes, returns and the value of a dollar by fully explaining the steps involved in the process and the reasons behind each step they are taking. If you don’t have all the answers…don’t stress…there are plenty resources out there today that you can turn to for help.
With tax day looming, it’s a great time to review your current retirement savings strategies and make any changes that are necessary in an effort to keep your plan on track for long-term financial security. This time of year is also a perfect time to start an IRA if you haven’t done so already.
The IRS allows contributions to an IRA up to April 15, 2014 for the 2013 tax year.
There are two types of IRAs available: a traditional IRA and a Roth IRA. The principal difference between the two is the tax treatment of contributions and distributions or withdrawals.
The traditional IRA may allow a tax deduction based on your contribution, depending on your income level. Earnings on this type of account compound on a tax-deferred basis. In other words, distributions are taxable at the time of withdrawal at the then-current income tax rates.
The Roth IRA doesn’t allow a deduction for contributions. However, earnings and qualified withdrawals are tax-free.
When deciding whether a traditional IRA or a Roth IRA is the right choice for you, you need to weigh the immediate benefit of the tax deduction and earnings that compound on a tax-deferred basis against tax-free distributions in retirement.
If you need the tax deduction to help lower your tax bill this year – and you qualify for it – then you may want to opt for the traditional IRA.
To qualify for the full annual IRA deduction in 2013, you must either: 1. Not be eligible to participate in a company retirement plan, or 2. If you are eligible, you must have an adjusted gross income of $59,000 or less for singles, or $95,000 or less for married couples filing jointly. If you are not eligible for a company plan but your spouse is, your traditional IRA contribution is fully deductible as long as your combined gross income does not exceed $178,000.
If you are covered by a retirement plan at work, your 2013 deduction will be reduced if your modified adjusted gross income (MAGI) is:
Between $95,000 and $115,000 for a married couple filing a joint return for the 2013 tax year.
Between $59,000 and $69,000 for a single individual or head of the household for the 2013 tax year.
You must also consider the tax bracket you think you will be at retirement. If you expect your tax bracket to drop considerably and you qualify for the deduction, the traditional IRA may be the better choice.
If, based on the scenarios above, you don’t qualify for the deduction and/or you expect that your tax bracket will not be significantly lower; a Roth IRA may be the better option.
You should maximize your IRS allowable contributions if financially possible. The maximum is $5,500 per individual, plus an additional $1,000 annually if you are aged 50 and older for 2013. Note, those amounts are per individual not per IRA.
Not everyone can afford to maximize his/her annual IRA contribution, especially if you are already contributing to an employer retirement plan. If your workplace plan offers an employer’s matching contribution, then this “free” money may be more of an incentive to than the annual IRA deduction. If this is the case, it may make more sense to maximize the employer matched plan first and then try to maximize your contributions to your IRA.
The important takeaway from this information is that you shouldn’t hesitate to use the remaining time between now and April 15 to contribute or start an IRA. The ability for you to live comfortably in retirement depends on it.
Note: The above article is intended to provide generalized financial information for educational purposes only. It is not intended to give personalized tax, investment, legal or other business or professional advice. Before taking any action, you should always seek the assistance of a professional.