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Ultimate Guide to Maximizing Your 401(k)

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

You’re probably familiar with the basics of a 401(k). You know that it’s a retirement account, offered by your employer. You know that you can contribute a percentage of your salary, and that you get tax breaks on those contributions. And you may know that your employer might offer matching contributions.

But beyond the basics, you may have some confusion about exactly how your 401(k) works and what you should be doing to maximize its benefits. This guide will tell you everything you need to know so that you could max out your 401(k) contributions.

The 4 types of 401(k) contributions

When it comes to maximizing your 401(k), nothing you do is more important than maximizing your contributions. While most investment advice focuses on how to build the elusive perfect portfolio, the truth is that your savings rate is much more important than the investments you choose.

While it is important to build a balanced portfolio, make sure you don’t neglect the easy stuff like maxing out a 401(k). This is especially true when you’re just starting out.

There are four different ways to contribute to your 401(k), and understanding how each one works will allow you to combine them in the most efficient way possible for your needs. By adding more money, you’ll be inching closer to a financially secure retirement.

1. Employee contributions

Employee contributions are the only type of 401(k) contribution that you have full control over, and they are likely to be the biggest source of your 401(k) funds. That’s because these are the contributions that you make to your 401(k). Employee contributions are typically a percentage of your salary, automatically deducted directly from your paycheck each pay period.

The key here is that it’s up to you to decide what percentage to have deducted—up to a certain amount. In other words, employee contributions are your chance to get the most bang for your buck.

Let’s say that you earn $3,000 every two weeks. If you decide to contribute 5% of your salary to your 401(k). In this case, $150 will be automatically taken out of each paycheck and deposited directly into your 401(k). Automation is the advantage: Everyh week, a percentage of your pay is out of sight and stashed safely away for your golden years.

Maximum personal contributions

The IRS sets limits on how much you can contribute to your 401(k) in a given year. For 2019, employee contributions are capped at $19,000, or $25,000 if you’re age 50 or older. These limits will increase to $19,500 and $26,000, respectively, in 2020. In subsequent sections we’ll talk about how much you should be contributing in order to maximize these contributions.

Traditional 401(k) vs. Roth 401(k) contributions

There are two different types you need to choose from—a traditional 401(k) or a Roth 401(k)—each with a different set of tax benefits:

  • Traditional 401(k): Traditional 401(k) contributions are tax-deductible in the year that you make the contribution and grow tax-free while inside the 401(k). They are taxed as ordinary income when you withdraw the money in retirement.
  • Roth 401(k): Roth 401(k) contributions are not tax-deductible in the year you make a contribution, but they grow tax-free while inside the account—and you won’t pay taxes when you withdraw the money in retirement.

Both the Roth 401(k) and the traditional 401(k) have the same contribution and catch-up contribution limits, as well as a 10% early withdrawal penalty. The main difference between the two types of plans comes down to taxes, as reflected above.

If you have both options available, how do you choose the right one? It typically comes down to age. If you’re younger and just starting out in your career, the Roth 401(k) makes more sense, as you’re likely in the lowest tax bracket you’ll ever be in and thus you’ll pay lower taxes on contributions. If you’re more advanced in your career, it might make sense to go with a traditional 401(k), because 100% of your contributions are invested, giving them maximum chance to grow.

2. Employer matching contributions

Many employers match your contributions up to a certain point, meaning that they contribute additional money to your 401(k) each time you make a contribution.

Employer matching contributions are only somewhat in your control. You can’t control whether your employer offers a match or the type of match they offer, but you can control how effectively you take advantage of the match they do offer.

Taking full advantage of your employer match is one of the most important parts of maximizing your 401(k). Skip ahead to this section to learn more on how to maximize your employer match.

3. Employer non-matching contributions

Non-matching contributions are contributions that your employer makes to your 401(k) regardless of how much you contribute. Some companies offer this type of contribution in addition to, or in lieu of, regular matching contributions.

For example, your employer might contribute 5% of your salary to your 401(k) no matter if or how much you contribute. Or, your employer might make a variable contribution based on the company’s annual profits.

It’s important to note that these contributions are not within your control. Your employer either makes them or not, no matter what you do.

However, these contributions can certainly affect how much you need to save for retirement, since more money from your employer may mean that you don’t personally have to save as much. Or, these contributions could be viewed as additional free savings that help you reach financial independence even sooner.

4. Non-Roth after-tax contributions

This last type of contribution is rare. Many plans don’t even allow this type of contribution, and even when they do, these contributions are rarely utilized. To find out if your 401(k) plan does allow these contributions—many do not allow them—you can refer to your 401(k)’s summary plan description.

And even if these contributions are allowed, it typically only makes sense to take advantage of them if you’re already maxing out all of the other retirement accounts available to you.

But if you are maxing out those other accounts, you want to save more and your 401(k) allows these contributions, they can be a powerful way to get even more out of your 401(k).

How non-Roth after-tax 401(k) contributions work

Non-Roth after-tax 401(k) contributions are sort of a hybrid between Roth and traditional contributions. They are not tax-deductible, like Roth contributions, which means they are taxed first and then the remaining money is what is contributed to your account. The money grows tax-free while inside the 401(k), but the earnings are taxed as ordinary income when they are withdrawn. The contributions themselves are not taxed again.

Here’s a quick example to illustrate how the taxation works:

  1. You make $10,000 of non-Roth after-tax contributions to your 401(k). You are not allowed to deduct these contributions for tax purposes.
  2. Over the years, that $10,000 grows to $15,000 due to investment performance.
  3. When you withdraw this money, the $10,000 that is due to contributions is not taxed. However, the $5,000 that is due to investment returns — your earnings — is taxed as ordinary income.

The value of non-Roth after-tax 401(k) contributions

This hybrid taxation means that on their own non-Roth after-tax contributions are typically not as effective as either pure traditional or Roth contributions.
However, they can be uniquely valuable in two big ways:

  • You can make non-Roth after-tax contributions in addition to the $19,000 annual limit for 2019 on regular employee contributions, giving you the opportunity to save even more money. They are only subject to the $56,000 annual limit in 2019 ($62,000 if eligible for catch-up contributions) that combines all employee and employer contributions made to a 401(k).
  • These contributions can be rolled over into a Roth IRA when you leave your company or even while you’re still working there. And once the money is in a Roth IRA, the entire balance, including the earnings, grows completely tax-free. This contribution rollover process has been coined the Mega Backdoor Roth IRA, and it can be an effective way for high-income earners to stash a significant amount of tax-free money for retirement.

How to maximize your 401(k) employer match

Now that you have an understanding of the types of contributions available to you, it’s time to start maximizing them. The first step is making sure you’re taking full advantage of your employer match.

Simply put, your 401(k) employer match is almost always the best investment return available to you. Because with every dollar you contribute up to the full match, you typically get an immediate 25%-100% return. It’s free money — and you want free money.

How a 401(k) employer match works

While every matching program is different, a typical plan offers a partial match or a dollar-for-dollar match. The names clue you into how they work. A partial match means your employer agrees to match a certain percentage of your contributions, up to a specified point. For example, your company could match 50% of your contributions up to 6% of your salary. That means if you contribute 4% of your salary, your employer will contribute 2%.

A dollar-for-dollar match means that your employer has agreed to match 100% of your contributions, up to a specified point. So if you contribute 5% of your income to your 401(k), your employer also contributes 5%. Just like the partial match, anything above the match limit is not matched.

How does this work in the real world? Well, let’s say that you make $3,000 per paycheck and that you contribute 10% of your salary to your 401(k). That means that $300 of your own money is deposited into your 401(k) as an employee contribution each paycheck, and your employer matching contribution breaks down as follows:

  1. The first 3% of your contribution, or $90 per paycheck, is matched at 100%, meaning that your employer contributes an additional $90 on top of your contribution.
  2. The next 2% of your contribution, or $60 per paycheck, is matched at 50%, meaning that your employer contributes an additional $30 on top of your contribution.
  3. The next 5% of your contribution is not matched.

All told, in this example, your employer contributes an extra 4% of your salary to your 401(k) as long as you contribute at least 5% of your salary. That’s an immediate 80% return on investment.
That’s why it’s so important to take full advantage of your 401(k). There’s really no other investment that provides such an easy, immediate and high return.

How to find your 401(k) employer matching program

On a personal level, taking full advantage of your employer match is simply a matter of contributing at least the maximum percentage of your salary that your employer is willing to match. In the example above, that would be 5%, but the actual amount will vary from plan to plan.

So your job is to find out exactly how your employer matching program works, and the good news is that it shouldn’t be too hard. These are the two main pieces of information you’re looking for:

  1. The maximum contribution percentage your employer will match. This is the amount of money you’d need to contribute in order to get the full match. For example, your employer might match your contribution up to 5% of your salary, as in the example above, or it could be 3%, 12% or any other percentage. Whatever this maximum percentage is, you’ll want to do what you can to contribute at least that amount so that you get the full match.
  2. The matching percentage. Your employer might match 100% of your contribution, or they may only match 50%, or 25%, or some combination of all of the above. This has a big effect on the amount of money you actually receive. For example, two companies might both match up to 5% of your salary, but one might match 100% of that contribution, and one might only match 25% of it. Both are good deals, but one is four times as valuable.

With those two pieces of information in hand, you’ll know how much you need to contribute to get the full match and how much extra money you’ll be getting each time you make that contribution.

As for where to find this information, the best and most definitive source is your 401(k)’s summary plan description, which is a long document that details all of the ins and outs of your plan. This is a great resource for all sorts of information about your 401(k), but you can specifically look for the word “match” to find the details on your employer matching program.

And if you have any trouble either finding the information or understanding it, you can reach out to your human resources representative for help. You should be able to find their contact information in the summary plan description.

Two big pitfalls to avoid with your 401(k) employer match

Your employer match is almost always a good offer, but there are two pitfalls to watch out for: vesting and front-loading contributions. Both of these could either diminish the value of your employer match or cause you to miss out on getting the full match.

Pitfall #1: Vesting

Employer contributions to your plan, including matching contributions, may be subject to something called a vesting schedule.

A vesting schedule means that those employer contributions are not 100% yours right away. Instead, they become yours over time as you accumulate years of service with the company. If you leave before your employer contributions are fully vested, you will only get to take some of that money with you.

For example, a common vesting schedule gives you an additional 20% ownership over your employer’s contributions for each year you stay with the company. If you leave before one year, you will not get to keep any of those employer contributions. If you leave after one year, you will get to keep 20% of the employer contributions and the earnings they’ve accumulated. After two years, you will get to keep 40%, and so on, until you’ve earned the right to keep 100% of your employer’s contributions after five years with the company.

Three things to know about vesting:

  1. Employee contributions are never subject to a vesting schedule. Every dollar you contribute and every dollar that money earns is always 100% yours, no matter how long you stay with your company. Only employer contributions are subject to vesting schedules.
  2. Not all companies have a vesting schedule. In some cases, you might be immediately 100% vested in all employer contributions.
  3. There is a single vesting clock for all employer contributions. In the example above, all employer contributions will be 100% vested once you’ve been with the company for five years, even those that were made just weeks earlier. You are not subject to a new vesting period with each individual employer contribution.

Should vesting affect how you invest?

A vesting schedule can decrease the value of your employer match. A 100% match is great, but a 100% match that takes five years to get the full benefit of is not quite as great.

Still, in most cases it makes sense to take full advantage of your employer match, even if it’s subject to a vesting schedule. And the reasoning is simply that the worst-case scenario is that you leave your job before any of those employer contributions vest, in which case your 401(k) would have acted just like any other retirement account available to you, none of which offer any opportunity to get a matching contribution.

However, there are situations in which a vesting schedule might make it better to prioritize other retirement accounts before your 401(k). In some cases, your employer contributions might be 0% vested until you’ve been with the company for three years, at which point they will become 100% vested. If you anticipate leaving your current employer within the next couple of years, and if your 401(k) is burdened with high costs, you may be better off prioritizing an IRA or other retirement account first.

You may also want to consider your vesting schedule before quitting or changing jobs. It certainly shouldn’t be the primary factor you consider, but if you’re close to having a significant portion of your 401(k) vest, it may be worth waiting just a little bit longer to make your move.

You can find all the details on your 401(k) vesting schedule in your summary plan description. And again, you can reach out to your human resources representative if you have any questions.

Pitfall #2: Front-loading contributions

In most cases, it makes sense to put as much money into your savings and investments as soon as possible. The sooner it’s contributed, the more time it has to compound its returns and earn you even more money.

But the rules are different if you’re trying to max out your employer match. The reason is that most employers apply their maximum match on a per-paycheck basis. That is, if your employer only matches up to 5% of your salary, what they’re really saying is that they will only match up to 5% of each paycheck.

For a simple example, let’s say that you’re paid $18,000 twice per month. So over the course of an entire year, you make $432,000. In theory, you could max out your annual allowed 401(k) contribution with your very first paycheck of the year. Simply contribute 100% of your salary for that one paycheck, and you’re done.

The problem is that you would only get the match on that one single paycheck. If your employer matches up to 5% of your salary, then they would match 5% of that $18,000 paycheck, or $900. The next 23 paychecks of the year wouldn’t get any match because you weren’t contributing anything. And since you were eligible to get a 5%, $900 matching contribution with each paycheck, that means you’d be missing out on $20,700.

Spreading out contributions to take full advantage of your employer match

Now, most people aren’t earning $18,000 per paycheck, so the stakes aren’t quite that high. But the principle remains the same.

Still, to get the full benefit of your employer match, you need to set up your contributions so that you’re contributing at least the full matching percentage every single paycheck. You may be able to front-load your contributions to a certain extent, but you want to make sure that you stay far enough below the annual $18,000 limit to get the full match with every paycheck.

Now, some companies will actually make an extra contribution at the end of the year to make up the difference if you contributed enough to get the full match but accidentally missed out on a few paychecks. You can find out if your company offers that benefit in your 401(k)’s summary plan description.

But in most cases, you’ll need to spread your contributions out over the entire year in order to get the full benefit of your employer match.

When to contribute more than is needed for your employer match

Maxing out your employer match is a great start, but there’s almost always room to contribute more.

Using the example from above, the person with the $3,000 per-paycheck salary would max out his or her employer match with a 5% contribution. That’s $150 per paycheck. Assuming 26 paychecks per year, that individual would personally contribute $3,900 to his or her 401(k) over the course of a year with that 5% contribution.

And given that the maximum annual contribution for 2019 is $19,000 for 2019 ($25,000 if you’re 50+), the person in the above example would still be eligible to contribute an additional $14,100 per year. In fact, this individual would have to set their contribution to just over 23% in order to make that full $18,000 annual contribution.

3 big questions to answer to decide whether to save more

To figure out if you should be contributing more to your retirement savings, there are three big questions you’ll need to answer

  1. Do you need to contribute more in order to reach your personal goals?
  2. Can you afford to contribute more right now?
  3. If the answer is yes to both #1 and #2, should you be making additional contributions to your 401(k) beyond the employer match, or should you be prioritizing other retirement accounts?

Questions #1 and #2 are beyond the scope of this guide, but you can get a sense of your required retirement savings here and here.

Question #3 is what we’ll address here. If you’ve already maxed out your employer match and you want to save more money for retirement, should you prioritize your 401(k) or other retirement accounts?

We’ll dive into that in the next section.

What other retirement accounts are available to you?

Your 401(k) is almost never the only retirement account available to you. Here are the other major options you might have to invest outside of your 401(k).

IRA

An IRA is a retirement account that you set up on your own, outside of work. You can contribute up to $6,000 per year for 2019 and 2020 ($7,00 if you’re 50+). Just like with the 401(k), there are two different types of contributions you can make:

  1. Traditional IRA contribution: You get a tax deduction on your contributions, your money grows tax-free inside the account and your withdrawals are taxed as ordinary income in retirement.
  2. Roth IRA contribution: You do not get a tax deduction on your contributions, but your money grows tax-free and can be withdrawn tax-free in retirement.

The big benefit of IRAs is that you have full control over the investment company you use, and therefore the investments you choose and the fees you pay. While some plans force you to choose between a small number of high-cost investments, IRAs give you a lot more freedom to choose better investments.

One catch for the Roth IRA is that there are income limits that may prevent you from being allowed to contribute or to deduct your contributions for tax purposes. If you earn more than those limits, a Roth IRA may not be an option for you.

Health savings account

Health savings accounts, or HSAs, were designed to be used for medical expenses, but they can also function as a high-powered retirement account.

In fact, health savings accounts are the only investment accounts that offer a triple tax break:

  1. Your contributions are deductible.
  2. Your money grows tax-free inside the account.
  3. You can withdraw the money tax-free for qualified medical expenses.

On top of that, many HSAs allow you to invest the money, your balance rolls over year to year and, as long as you keep good records, you can actually reimburse yourself down the line for medical expenses that occurred years ago.

Put all that together with the fact that you will almost certainly have medical expenses in retirement, and HSAs are one of the most powerful retirement tools available to you.

The catch is that you have to be participating in a qualifying high-deductible health plan, which generally means a minimum annual deductible of $1,350 for individual coverage and $2,700 for family coverage.

If you’re eligible, though, you can contribute up to $3,500 if you are the only individual covered by such a plan, or up to $7,000 if you have family coverage.

Backdoor Roth IRA

If you’re not eligible to contribute to an IRA directly, you might want to consider something called a backdoor Roth IRA.

The backdoor Roth IRA takes advantage of two rules that, when combined, can allow you to contribute to a Roth IRA even if you make too much for a regular contribution:

  1. You are always allowed to make non-deductible traditional IRA contributions, up to the annual $6,000 limit, no matter how much you make.
  2. You are also allowed to convert money from a traditional IRA to a Roth IRA at any time, no matter how much you make.

When you put those together, high-earners could make non-deductible contributions to a traditional IRA, and shortly after convert that money to a Roth IRA. From that point forward, the money will grow completely tax-free.

Though there are some potential pitfalls to backdoor Roth IRAs, it can be a good option to have in your back pocket if you are otherwise ineligible to make IRA contributions.

Taxable investment account

While dedicated retirement accounts offer the biggest tax breaks, there are plenty of tax-efficient ways to invest within a regular taxable investment account as well.

These accounts can be especially helpful for nearer term goals, since your money isn’t locked away until retirement age, or for money that you’d like to invest after maxing out your dedicated retirement accounts.

How to decide between additional 401(K) contributions and other retirement accounts

With those options in hand, how do you decide whether to make additional contributions, beyond the amount needed to max out the employer match, or to contribute that money to other accounts?

There are a few big factors to consider:

  • Eligibility: If you’re not eligible to contribute to an IRA or HSA, a 401(k) might be your best option by default.
  • Costs: Cost is the single best predictor of future investment returns, with lower cost investments leading to higher returns. You’ll want to prioritize accounts that allow you to minimize the fees you pay.
  • Investment options: You should prioritize accounts that allow you to implement your preferred asset allocation, again with good, low-cost funds.
  • Convenience: All else being equal, having fewer accounts spread across fewer companies will make your life easier.

With those factors in mind, here’s a reasonable guide for making the decision:

  1. Max out your employer match before contributing to other accounts.
  2. If your 401(k) offers low fees and investments that fit your desired portfolio, you can keep things simple by prioritizing additional contributions there first. This allows you to work with one account, at least for a little while, instead of several.
  3. If your 401(k) is high-cost, or if you’ve already maxed out your 401(k), a health savings account may be the next best place to look. If you can pay for your medical expenses with other money, allowing this account to stay invested and grow for the long term, that triple tax break is hard to beat.
  4. An IRA is likely your next best option. You can review this guide for a full breakdown of the traditional versus Roth IRA debate.
  5. If you’re not eligible for a direct IRA contribution, you should consider a backdoor Roth IRA.
  6. If you maxed out your other retirement accounts because your 401(k) is high-cost, now is probably the time to go back. While there are some circumstances in which incredibly high fees might make a taxable investment account a better deal, in most cases the tax breaks offered by a 401(k) will outweigh any difference in cost.
  7. Once those retirement accounts are maxed out, you can invest additional money in a regular taxable investment account.

The bottom line: Maximize your 401(k)

A 401(k) is a powerful tool if you know how to use it. The tax breaks make it easier to save more and earn more than in a regular investment account, and the potential for an employer match is unlike any opportunity offered by any other retirement account.

The key is in understanding your plan’s specific opportunities and how to take maximum advantage of them. If you can do that, you may find yourself a lot closer to financial independence than you thought.

Chris O’Shea contributed to this report.

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Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt here

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News

A Guide to Doing Your Taxes for the Very First Time

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

iStock

Filing taxes can be intimidating no matter how many times you’ve done it, but it can be especially challenging if it’s your first time.

What documents do you need to collect? What information do you need to report? What deadlines do you have to meet? What if you make a mistake?

It’s a lot to keep track of and there’s a fair amount at stake as well. Accurately filing your taxes will not only help you avoid potential penalties, but it will ensure that you get the maximum refund possible.

This article will guide you through the entire process so that you know how to successfully file your taxes for the first time.

How to decide whether you need to file a return

Not everyone needs to file a federal income tax return, though if you worked for any significant part of the year, it is likely that you do.

You generally need to file a tax return if you earned more than the standard deduction amount, which for 2018 is $12,000 for single filers, $24,000 for married couples filing jointly and $18,000 for anyone filing as head of household. If you’re claimed as a dependent on someone else’s tax return, such as your parents, you generally need to file a return if you made more than $1,050 during the year.

But even if you don’t meet those thresholds, there are still situations in which it may make sense to file a return.

“If you paid federal and state withholding taxes, you would need to file a return in order to potentially get a refund,” said Chris Panek, a CPA in Avon, Minn.

You also need to file a return to qualify for certain tax credits, such as the Earned Income Tax Credit (EITC), which can put a significant amount of money back in your pocket if you’re working but earning a low income.

At the end of the day, it’s often worth filing unless you’re absolutely certain that you don’t need to file and that you won’t qualify for a refund or any tax credits.

“There’s no risk to filing a return,” said Panek. “You need to file a return in order to potentially get a refund, and if you do file a return and didn’t need to, there shouldn’t be any risk at all.”

If you’d like some help deciding whether it’s worth filing a tax return, you can use the following tool provided by the IRS: Do I Need to File a Tax Return?

The tax filing deadlines you need to meet

April 15 is the standard tax filing deadline, but that date can be adjusted for weekends and holidays. In 2019, the tax filing deadline is April 17.

Meeting this deadline is critical because failure to file on time can have several negative consequences.

First, you may be subject to a failure-to-file penalty, which is typically calculated as up to 5% of your unpaid taxes for each month that you’re late, with a maximum penalty of 25% of your unpaid taxes.

Second, if you haven’t paid your taxes in full by the deadline, you may be subject to a penalty as well, typically calculated as 0.5%-1% of your unpaid taxes for each month that you’re late, though the combined failure-to-file penalty and failure-to-pay penalty can’t be more than 5% in any given month.

Finally, you won’t receive your refund or be able to claim tax credits unless you file. You do have three years from the original due date in order to file and claim a refund, but, again, waiting can subject you to penalties, and in any case receiving that refund earlier is better than receiving it later.

If, for whatever reason, you are having trouble filing an accurate return by the April 17 deadline, you are allowed to request an automatic six-month extension that gives you until Oct. 15 to file your return. There are no eligibility requirements to get an extension, and requesting an extension by April 17 will allow you to avoid the failure-to-file penalties as long as you meet that Oct.15 deadline.

It’s worth noting, however, that the extension only applies to the filing of your return and not to the payment of your tax liability. You still need to pay in full by April 17 in order to avoid the failure-to-pay penalty.

“I would highly recommend that you get your return done by April 15,” said Panek. “A lot of times people aren’t thinking about their taxes by the time extensions are due, and if you do owe money, that’s still due on April 15.”

How to collect and organize the necessary tax documents

One of the most confusing parts of filing your taxes, especially the first time around, is knowing which tax forms you need to collect, when you should expect to receive them and how to keep everything organized so that you’re ready when it’s time to put it all together.

The first step is to simply have a basic system for keeping everything organized so that whenever you do receive a document, you’ll have somewhere to keep it.

“I definitely recommend to clients, especially if they’re getting a lot of documents in the mail, that they keep a folder where they can keep them all,” said Panek. “Every time you receive something, put it in that folder and just let it accumulate so that when [you] start your return, you have all of it ready to go.”

According to Panek, most tax documents have to be sent out by Jan. 31. That includes W-2s that report your earned income from your employers, 1099-INTs that report interest earned on your bank accounts and 1099-DIVs that report dividend income earned from your investments.

Other forms you might need to collect, depending on your situation, include:

  • Form 1098 – Reports mortgage interest paid during the year.
  • Form 1099-MISC – Reports income earned as an independent contractor.
  • Forms 1095-A, B and C – Reports on your health insurance coverage.
  • Form 1098-E – Reports on student loan interest paid during the year.
  • Schedule K-1 – Reports income earned as part-owner of a business. According to Panek, these forms typically aren’t required to be sent out until March 15.
  • Receipts for charitable deductions, medical expenses and child care expenses that could potentially be deductible.

While you don’t want to wait until the last minute to file your taxes, Panek recommends that you do give it some time so that you can be sure you have everything you need before starting the process.

“You want to make sure that you have all your forms before you file so you don’t have to go back and amend that return,” said Panek. “Since everything is sent out by Jan. 31, it wouldn’t be beneficial to file your taxes before then unless you’re absolutely sure that you have all the forms you need.”

How to file your taxes

Once you’ve decided that you need to file a return and you’ve collected all the documents you think you’ll need, it’s time to file your taxes.

There are a few different ways to go about it, and the right choice depends on the specifics of your situation.

Option #1: IRS free e-file

If you make $66,000 or less, you are eligible to use the IRS’ free tax-filing software that guides you through the process of filling out the return. If you make more than $66,000, you can use the free fillable forms offered by the IRS, though you won’t have the benefit of software to guide you through them.

If your income is low enough to qualify for the free software, and if your overall tax situation is relatively simple, this option may be a no-brainer.

“This can be great if you have a simple return, meaning that you’re simply getting a W-2 from your employer and you potentially have some simple investments,” said Panek.

The fillable forms can also be useful, but Panek warns that since you don’t receive the same kind of guidance, it’s a better option for people who have a stronger foundation in taxes.

“A lot of people will use the free services when they understand the tax law,” said Panek. “But if you are filing a return and you’re not sure about what you should be entering in, I would seek out a professional tax preparer to help you out.”

Option #2: Tax preparation software

If you don’t qualify for the free IRS e-file option, and if your situation isn’t complicated enough to hire a professional tax preparer, paying for tax preparation software may be a good middle ground.

The cost of tax preparation software ranges from just a few dollars to almost $200, depending on the complexity of your situation. And while you don’t get the expertise of a professional reviewing your situation, you do benefit from more guidance than you would get if you filed your taxes on your own.

“The software will guide through some questions to help you understand what you need to report,” said Panek. “If you have a simple enough return and you feel comfortable with the software, it’s fine to do this on your own.”

Option #3: Professional tax preparer

If you have a complicated tax situation, are unsure about anything in your return, or if you’d like a little guidance about how to minimize your tax payments, it may be worth paying to work with a professional tax preparer.

“Whenever you feel that your tax return is getting more complicated, or you’re unsure of how you should be adjusting things within your tax return, I always suggest that you seek out a professional,” said Panek. “The nice thing is that they’ll be able to sit down with you and go more in-depth, and they may ask questions that otherwise wouldn’t come up.”

In addition to making sure that the current year’s return is done right, Panek said that a professional tax preparer could help you make decisions like how much to contribute to your employer retirement plan next year by showing you exactly how those contributions would affect your return. If you’re starting a business, a tax professional could also make sure that you set it up properly with a tax ID and help you understand which expenses are deductible.

The biggest downside to working with a professional is the cost. It can vary a lot depending on the type of professional you use and the scope of service you need, but it will almost certainly cost more than using tax preparation software.

Still, Panek says that in many cases, the cost will be worth it and that it may not be quite as burdensome as it seems on the surface.

“If you’re looking at something like TurboTax, the dollar amount that you’re spending on the software could go right to the person you’re paying to prepare your taxes,” said Panek. “A tax preparer can even first help you with the question of whether you need to file, and then you can decide whether you want to hire them to help you out.”

There are a number of factors to consider when hiring a tax preparer, and the IRS offers two useful resources to help you make a good decision:

When you can expect a refund

One piece of good news when it comes to filing taxes is that if you’re owed a refund, you will typically receive it fairly quickly. According to the IRS, most refunds are issued in less than 21 days and you can check the status of your refund within 24 hours of filing an electronic return.

“It varies in terms of how fast they come back and what you have going on in your tax return,” said Panek. “But I’ve had people who have gotten their refunds back by the next week.”

You can choose to receive your refund either via mail or by direct deposit into your bank account. According to the IRS, choosing direct deposit is both more secure and it allows you to get your refund quicker. You can even choose to split your refund among three different bank accounts if you’d like.

Of course, while it’s always nice to receive a big chunk of money all at once, there’s plenty of debate over the benefits of a refund compared with reducing your withholding so that you receive more money in your paychecks over the course of the year.

On the one hand, getting that refund can help you pay off debt, build savings or fund a college savings account in one fell swoop. On the other hand, a big refund means that you’ve essentially been loaning the government money for the past year, money that could have been yours to do with as you pleased.

“Some people that rely on that big refund because they’re not savers and they would rather have the government save that money for them,” said Panek. “Other people don’t want their money anywhere else. If there’s money that should be theirs, they want to be saving it themselves.”

“I personally like to get my clients as close to their actual tax liability as possible,” added Panek. “That way, they’re not getting a big refund and don’t owe a big tax bill.”

If, after filling out your taxes, you feel like your refund was either too big or too small, you can fill out a new W-4 and submit it to your employer so that they can adjust your withholding up or down. The IRS can help you figure out how to make those adjustments with their Paycheck Checkup tool.

Other common tax questions

Every tax situation is different, so you may still have questions even after reviewing all of the information above. The IRS offers a helpful FAQ that addresses many of the most common questions, and here are a few more answers that may point you in the right direction.

How will the new tax law affect me?

With the 2018 tax reforms in effect, one big question is how the new rules will affect your personal tax return.

The truth is that there are a lot of variables in every tax return, so there’s no way to say for certain how you will be affected. For example, a higher standard deduction will largely help people who don’t itemize their deductions, but a stricter limit on state and local tax deductions may hurt people in high-tax states, such as California and New York.

On the whole, income tax brackets have largely been decreased, which means that many people may see at least a small decrease in their tax bill compared with recent years. But the only way to know for sure is to do your taxes as accurately as possible and see where things land.

How can I reduce my tax liability?

There aren’t many ways to reduce your tax liability after Dec.31, but you do have until April 15 to make traditional IRA contributions for the prior year and those contributions are deductible on your tax return.

If eligible, you can contribute up to $5,500 to your IRA for 2018 (it’s $6,500 if you are age 50 or older). If you’re married, your spouse can potentially make another $5,500 contribution, allowing you to reduce your taxable income by as much as $11,000.

How do I pay taxes I owe?

If you file your return and find out that you owe taxes, remember that you have until April 17 to make that payment, or else you may be subject to penalties.

The IRS offers several different ways to pay, including paying directly from your bank account, by debit or credit card, or sending in a check.

What if I can’t afford to pay?

If you can’t afford to pay the taxes you owe, you can file an online payment agreement that may allow you to delay payment for up to 120 days or to create an installment plan so that you can make payments over time. You can also call the helpline at 800-829-1040 to discuss your options with a representative.

File without fear

Although filing your taxes for the first time can feel overwhelming and intimidating, the truth is that there’s not much to fear. The main potential penalties are associated with not filing, and as long as you meet the deadlines, there are ways to work with the IRS even if you owe money.

The keys to filing your return successfully are simply to be on the lookout for tax documents that come your way, keep them organized in a place where you’ll remember them and use whatever guidance you need in completing your return on time.

As long as you do those things, you should be just fine.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt here

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Pay Down My Debt

When Should You Consider Bankruptcy & How to File

bankruptcy guide
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Updated – November 14, 2018

If you’re drowning in debt and having trouble keeping up with your payments while still handling your living expenses, you may have at least begun to consider filing for bankruptcy.

Filing for bankruptcy is meant to give people in serious financial distress some relief and a chance to start over. By the time most people get to that point, they’ve probably tried many other methods for managing their debt.

Bankruptcy certainly has its benefits, potentially allowing you to wipe the slate clean and start anew.

But there are a lot of things to consider before making a decision, from the negative consequences of filing to whether bankruptcy would even provide relief for your specific situation.

“For most folks that come in, this is the last option,” said John Colwell, a San Diego, Calif.-based bankruptcy attorney and President of National Association of Consumer Bankruptcy. “I know I’m like the dentist. People really don’t want to be sitting in front of me.”

This is a big decision that requires a significant amount of due diligence before moving forward. While it’s important not to take bankruptcy lightly, it may be the best way for people to get back on their feet.

So how do you know if bankruptcy is the right way to relieve your debt? In this post, we’ll go over some of the key points to help you get started.

The basics of filing for bankruptcy

Bankruptcy is a legal procedure to discharge debt built up by someone who either will not be able to repay those debts or does not have the means to repay debts owed currently. There are two notable forms of bankruptcy: Chapter 7 and Chapter 13.

In a Chapter 7 bankruptcy, a debtor’s nonexempt assets are sold and the proceeds are used to pay debts. An individual must pass a means test before they can file a Chapter 7 bankruptcy to ensure that the court would not be abusing the bankruptcy law by granting one. We will talk more about the means test below!

A Chapter 13 bankruptcy is a “wage earner plan.” To qualify, an individual must have a steady income. This allows them to pay back all or part of their debts by developing a repayment plan. The plans last between three and five years.

In most cases, bankruptcy does not protect you from any future debts incurred. It also will have an effect on your credit score and remains on your credit report for 10 years with Chapter 7 and seven years with Chapter 13. In a Chapter 7 bankruptcy, you may lose assets such as your house or your car depending on how much equity, if you’re able to exempt your equity and if you’re current on your payments.

Are You Eligible?

As stated above, there are two types of bankruptcy for individuals: Chapter 7 and Chapter 13.

There are some significant differences between the two programs, but here’s a high-level summary:

  • Chapter 7 allows you to completely discharge your debts, with some exceptions (such as student loans, certain tax obligations, and child support). But you may be obligated to sell some of your property to settle some of your debt obligations.
  • Chapter 13 allows you to create a payment plan to repay some or all of your debts over a 3-5 year period. So your debts are not discharged, but you will also not be obligated to sell any property in order to make your payments.

Either one could be more or less beneficial depending on the specifics of your situation. But the very first question is whether you qualify for either one, and each has its own set of criteria.

Chapter 7 bankruptcy has what’s called the “means test”, which is meant to ensure that only people who truly can’t afford their debt payments are allowed to file. There are two different wants to pass it, and therefore qualify for Chapter 7 bankruptcy:

  1. If your monthly income is less than the median monthly income in your state for your family size, you pass. You can find current median income numbers by family size here.
  2. If you don’t pass #1, you’ll have to go through a complex calculation to see whether your disposable income after subtracting out certain expenses is enough to satisfy your debt obligations. At this stage it would probably be best to talk to a professional who could help you navigate the process.

Eligibility for Chapter 13 bankruptcy is a little more straightforward. Here’s how it works:

  1. As opposed to Chapter 7, you need to prove that your disposable income is high enough to afford a reasonable repayment plan.
  2. Your secured debt (mortgage, auto loan) can’t exceed $1,149,525, and your unsecured debt (credit cards, medical bills, etc.) can’t exceed $383,175.
  3. You must have filed both federal and state income taxes each of the last four years.

There are some other requirements for each, but those are the major ones. Assuming you qualify for at least one of them, there are a few other things to consider.

What Kinds of Assets and Liabilities Do You Have?

Depending on the specifics of your financial situation, one type of bankruptcy may be preferable to the other. Or it may be that neither would actually be particularly helpful.

As an example, neither type of bankruptcy would likely help you all that much if your primary debts are student loans. They wouldn’t be discharged in Chapter 7 bankruptcy. And while your required payments might be reduced over the 3-5 year repayment period in Chapter 13 bankruptcy, once that was over you would have to continue paying them back as usual.

The type of assets you own and their value also matters, particularly if you’re going through Chapter 7 bankruptcy. During that process, your bankruptcy trustee is allowed to sell your property in order to settle your debts, but certain property is protected.

For example, your house and car are protected up to certain limits. Employer retirement accounts like 401(k)s and 403(b)s are fully protected, while IRAs are protected up to about $1 million. But other accounts, such as checking, savings, and regular investment accounts may not have the same protections.

The rules here vary by state, and having a strong understanding of which assets you might be able to keep and which you might end up losing will help you make your decision.

When to file bankruptcy

According to Colwell, filing for bankruptcy needs to be “worth your while,” meaning it should give you relief from your debts to ensure you don’t find yourself in a similar situation in the near future. That means that if you have major expenses that you are about to incur, you should wait to file until after you have incurred them so they can be included in the bankruptcy settlement. This is especially important when it comes to filing bankruptcy due to medical bills.

However, with a Chapter 13 bankruptcy, you can seek court approval to include new debt that you’ve incurred post-filing into your payment plan.

In general, though, there are aspects of your financial situation that signal when it’s time to consider bankruptcy. If you can’t pay your bills (and you don’t see that changing anytime soon) and your debt continues to pile up, bankruptcy is probably worth considering.

Here are other red flags to look out for:

  1. Debt collectors are calling. If you’re behind on your bills to the point that you’re hearing from debt collectors, it may be time to consider bankruptcy. This is especially true if you’re being sued by debt collectors.
  2. You’re in danger of losing your home. If you’re at risk for losing your house to foreclosure, filing bankruptcy can help you get caught up on your payments and keep your home. With Chapter 13, you’re given the chance to keep your home by creating a plan to repay your outstanding debt.
  3. You’re using loans to pay your bills. Using short-term high-interest loans such as payday loans can get you in trouble. With these loans, people borrow against their next paycheck. “People get caught in the trap and it starts rolling over from paycheck to paycheck to paycheck,” said Colwell. Title loans are another form of small loan where a vehicle is used as collateral; these loans can be problematic for someone already in financial distress.
  4. You’re liquidating your retirement assets. Retirement money is exempt in a bankruptcy, meaning trustees can’t use it to repay lenders. So in most cases, it doesn’t make sense to burn through your retirement money to pay debts. “I hate that with a passion,” Colwell said. “It’s your retirement money, what are you doing?!”

How to file for bankruptcy

Most initial consultations with lawyers are free of charge. At these meetings, you’ll walk a bankruptcy attorney through your financial situation and your reasons for wanting to pursue bankruptcy.

There are also ways for individuals to file for bankruptcy on their own, known as filing pro se. Court employees and bankruptcy judges can’t give out legal advice to people in their courts, so if you go that route, you will be on your own. To file yourself, you should be familiar with the United States Bankruptcy Code, the Federal Rules of Bankruptcy Procedure and the local rules of the court.

Unless you have a strong understanding of legal issues and have the time to handle the paperwork, it’s probably best to use a lawyer — that’s because making a mistake can impact your rights, according to the U.S. Courts. You’ll also need the capacity to fill out a lot of paperwork, Colwell also noted.

If you use an attorney, they should be able to provide services including:

  • Advising you on whether to file a bankruptcy petition and under which chapter to file.
  • Telling you whether your debts can be discharged.
  • Advising you on whether or not you will be able to keep your home, car, or other property after you file.
  • Advising you of the tax consequences of filing.
  • Advising you on whether you should continue to pay creditors.
  • Helping you complete and file forms.

How to file Chapter 7 bankruptcy

A Chapter 7 bankruptcy involves the sale of all of your nonexempt assets to pay back your creditors. This is the most common kind of personal bankruptcy, accounting for more than 60 percent of all non-business bankruptcies in 2017. The process usually takes about four to five months.

Filing for Chapter 7 will wipe out your allowable debt (such as as credit card, medical and personal loan debt), but the bankruptcy will remain on your credit report for up to 10 years.

The first step is to take a mandatory credit counseling course from a government-approved organization, within 180 days of your filing date. Upon completion, you can decide if you still feel it appropriate to move forward with a bankruptcy, and move on to the next step.

At this point, you, or your attorney, would file your petition and other additional forms with the court. Along with your filing petition, the forms include a list of your creditors, a summary of your assets and liabilities, lists of property (both exempt and non-exempt) and any documentation needed for your “means test.” There are also companies that will send you a packet of all relevant documents, for a small fee.

At this point, you will be subject to the “means test.” If the debtor’s current monthly income is more than the state median, the means test is applied. Abuse is determined if the debtor’s monthly income over five years is either more than $12,850, or more than 25% of the debtor’s nonpriority unsecured debt of at least $7,700.

A trustee is then appointed to review the paperwork and take nonexempt property; you will also have to submit your most recent tax return to the trustee.

The next step in the process is a meeting of creditors, known as a “341 meeting.” At the meeting, you will answer questions about your finances and bankruptcy forms under oath. Creditors are allowed to attend the proceedings if they choose.

It is now decided if you are eligible to file for Chapter 7. At this stage, secured debts are determined: they can be repossessed by the creditor, you can redeem it by paying back what it’s worth or you can reaffirm the debt, which removes that debt from the bankruptcy filing and allows you to pay it back when the bankruptcy is over.

You will have another course to attend that will include information on developing a budget, using credit and managing money — afterward, your debt will be discharged.

Cost: A Chapter 7 bankruptcy needs to be paid for upfront by the debtor. It is generally a flat rate and may be contingent on the complexity of your debt structure as well as the market in which the attorney is operating.

How to file Chapter 13 bankruptcy

A Chapter 13 bankruptcy will last between three and five years, from start to finish. These processes are long and complex, so it’s strongly recommended that you use a lawyer. If you have a steady income, Chapter 13 bankruptcy allows you to keep property, like a house or car, that you might otherwise lose in Chapter 7. Chapter 13 develops a three-to-five year repayment plan for your debts.

The first step is to take a credit counseling course. Afterward, you or your attorney will prepare and file a bankruptcy petition and paperwork that includes a list of your creditors, a summary of your assets and liabilities and your Chapter 13 repayment plan; you will also need to provide your most recent tax returns.

The court will later appoint a trustee to administer your case and a stay on collections will take effect — this means that certain creditors won’t be able to proceed with lawsuits against you, call you for repayment or garnish your wages. You’ll begin making payments for a month after you file the paperwork. In addition, like Chapter 7, Chapter 13 also requires a 341 meeting.

You or your lawyer must attend a confirmation hearing where objections to your plan either by the trustee or the creditors will be addressed and eventually your plan for repayment will get confirmed.

Your creditors will also file proof of claim so that they can get repaid; it is at this point that you can object to the claim if you feel it is unfair.

The repayment period begins when you start to comply with your plan’s requirements and payments; this is the longest portion of the bankruptcy. If required by your plan, you may also have to submit documents to the court like income and expense statements.

Exactly as in Chapter 7, you’ll have another course to attend that goes over budgeting, using credit and managing money. Afterward, your debts may be discharged and your case closed.

Cost: There are two ways an attorney can charge you for handling your Chapter 13. It may be a “no look” fee, a flat fee set up by the district in your state, or they can bill you hourly. Your payment to your attorney can be worked into your Chapter 13 repayment plan.

Conclusion

Filing for bankruptcy is a big decision, and in the end you’re the only one who will know what’s right for you.

Bankruptcy can be not only a long process, but also a very emotional one for those seeking to discharge debts.

Do your research, evaluate all of your options, and then make the decision that most helps you reach your personal goals.

Looking into your options sooner rather than later may help you shore up your financial future and lose less in the long term.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt here

Kate Rockwood
Kate Rockwood |

Kate Rockwood is a writer at MagnifyMoney. You can email Kate here

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