Tax

Taxes are a complex and ever-changing topic. There’s no one-size-fits-all solution, as individual circumstances vary greatly. This playbook takes an incremental approach to help you build foundational knowledge and confidently begin your tax-planning journey.

Where to Start

If someone asks you the best way to learn a programming language, how would you respond? Most software engineers agree: the best way to learn is to write a small program yourself. Practice is key, and the same principle applies to understanding taxes.

The best way to learn about potential tax breaks and deductions is by filing your own tax return. For your next return, I strongly recommend using tax software like TurboTax, H&R Block, or TaxAct. Answer the questionnaire step by step and file it yourself. While this may be time-consuming and occasionally tedious, it’s the most effective way to gain a comprehensive understanding of how taxes are calculated, identify potential deductions, and make informed financial decisions for the following year.

Filing your taxes independently isn’t just about saving the cost of hiring an accountant. It’s an investment in your financial literacy, enabling you to recognize opportunities and avoid relying solely on secondhand advice.

Understanding Trade-Offs

Tax planning involves a series of trade-offs, much like solving complex software engineering problems. For every tax tool or strategy, the key trade-offs typically include:

  • Guaranteed Amount: How much money you are assured of receiving.
  • Liquidity: How quickly you can access the money.
  • Growth Opportunity: The potential for long-term returns.

When evaluating a tax strategy, consider these factors. The best choice depends on your financial priorities, whether they are maximizing guaranteed returns, preserving liquidity, or optimizing for growth. Only you can determine the right balance for your circumstances.

Retirement Plans

401(k)

Most software engineers are offered a 401(k) plan by their employers, making it one of the most powerful tax-saving tools available. Here are the key steps to optimize your 401(k):

  1. Maximize Employer Matching: Contribute enough to secure your employer’s full match, often between 50% and 200% of your contributions up to a certain limit. This is essentially free money—don’t leave it on the table.

  2. Contribute Pre-Tax to the IRS Limit: After maximizing the match, consider contributing the pre-tax maximum allowed by the IRS. Contributions reduce your taxable income for the current year, and you’ll only pay taxes when withdrawing in retirement—likely at a lower tax bracket.

  3. Consider After-Tax Contributions: If you can save more, some plans allow after-tax contributions. While you pay taxes upfront, earnings grow tax-free. This option is generally less attractive for beginners but worth exploring later in your financial journey.Some 401(k) plans include a “mega-backdoor IRA” feature, which offers additional benefits. This will be covered separately.

Individual Retirement Account (IRA)

Coming Soon

Health Savings Account (HSA)

For those with a high-deductible health plan (HDHP), a Health Savings Account (HSA) can be an excellent tax-advantaged tool.

  • Contributions to an HSA are tax-free.
  • Earnings grow tax-free.
  • Withdrawals for qualified medical expenses are tax-free.

If you’re in good health and rarely use healthcare services, an HDHP paired with an HSA can be cost-effective. Additionally, the HSA can serve as an additional retirement account. While annual contribution limits are modest, the tax benefits and long-term growth potential make it a valuable savings vehicle.

For example, I personally maximize my HSA contributions each year. I pay medical expenses out-of-pocket without claiming reimbursements from the HSA, allowing the account to grow over time. In retirement, when healthcare needs typically increase, this account will provide a significant tax-free resource.

529 Plan

Coming Soon

Home Ownership

Coming Soon

Disclaimer:

I am a software engineer based in New York State, USA, and the information I share here reflects my personal experiences and circumstances. This content is for informational and entertainment purposes only and should not be considered financial advice. I am not a licensed CPA or financial advisor.

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