Why Twentysomethings Should Prepare Their Own Tax Return -- At Least Once
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There are many rites of passage when you enter your 20s. From college graduation to starting your first job to finding your first apartment, major life events occur at a rapid pace. As these rites of passages occur, one thread that connects them all is learning how to create a financial life you will continue to nurture for decades.
To this end, there is one key rite of passage everyone in their 20s should NOT miss – preparing your own income tax return.
When faced with the idea of preparing a tax return, most people express a feeling of dread, which isn’t necessarily surprising. The IRS estimates that the "burden" of filing a 1040X for 2017 will take an average taxpayer approximately nine hours to complete. Not exactly the best way to spend a Saturday.
While it’s easy to just send your W-2 and 1099s off to a tax preparer (and you might do that in future years), if you don’t prepare your tax return at least once in your life, it is a missed opportunity to learn more about yourself financially. By preparing your own return, you will get a better understanding of how to maximize your overall financial life.
It’s Never Going to Be Easier
And why not prepare your taxes in your 20s? Your tax situation is never going to be simpler. Most twentysomethings have a W-2 and basic 1099s. They typically don’t itemize (and starting in 2018, many never will.) As a result, there is a good chance you could do the return on simple tax software like TurboTax in less than the estimated nine hours.
As you input your data, you will start to comprehend how the actual tax code works. It is good to simply read through the 1040 line by line. Why? Because you start to see how the tax code flows – from Income, to Adjustments to Income, to Credits and finally Taxes due.
The exercise will surface issues that can impact other areas of your financial life. For instance, if you end up with a substantial refund, there is a good chance you are withholding too much per pay period. This might give you a great opportunity to adjust your withholding to take more home on a per paycheck basis. Cash flow is paramount regardless of whether you are in your 20s or your 50s. Learning how to control aspects of it can really help you succeed financially.
Getting A Clearer Picture of Your Student Loan Debt
And then there is the ever-present issue of student loan debt. Millennials entering their working years are burdened by something earlier generations rarely had to face – student loan debt. They are paying higher interest rates than the generation before them. Student Loan Hero found that while there are 44.2 million Americans with student loan debt, the average monthly student loan payment for an individual 20 to 30 years old is $351.
Learning that there is some benefit to paying those loans is important – and something your tax return can show you. Student loan interest paid on a qualified loan can be deducted. In fact, you can deduct the lesser of $2,500 or the amount of interest paid. And this benefit is available to single taxpayers until they start to phase out at $65,000 to $80,000 of modified adjusted gross income. You don't need to itemize to take advantage of this deduction.
While it might not make you feel great about being in debt, understanding the tax advantage puts it in financial perspective.
Young Taxpayers Can Maximize Credits
You can also get credit for thinking ahead about retirement. An often overlooked Retirement Saver’s Credit is a unique tool in the tax code that originated in 2001. The intent of this credit is to encourage retirement savings – whether through a 401k, 403b or IRA, for lower to moderate income workers. Typically, people in their 20s are eligible for this credit.
Here’s what you need to know about eligibility. You must be 18 or older, not a full-time student and not be a dependent on another’s return. If you fund a retirement plan, you can get a credit of 50%, 20% or 10% of your retirement plan contribution up to $2,000 for Single filers. This is a credit that might only be available early in your career – and that is because for single filers, you phase out of the credit when your income crosses $31,000.
Ironically, while this credit offers a great opportunity for many young people, few are familiar with it. In fact, research conducted by the Transamerica Center for Retirement showed that 2 out of 3 American workers did not know about the credit. If you are actually preparing your own return, and the tax software asks if you funded a qualified plan, you can begin to see the other tax benefit of being retirement savvy in your 20s.
Just Do It
Ultimately making sure your return accurately reflects your finances is key to creating financial success. Consistently filing returns and paying taxes establishes a record on which to build your financial life. Whether applying for credit or buying a first home, information on the return is necessary for financial success. And if a relationship with a significant other gets serious, understanding your taxes is essential as you begin discussions about how to ensure good financial health as a couple.
So even if it is just once in your life, take a Saturday during early April, download the tax software, and starting inputting – it’s a positive step in your financial life.