Everyone likes to get a break on their tax bill. But for today’s struggling young adults, making sure you don’t pay any more in taxes than you have to and taking advantage of every available tax break is vitally important to starting your independent financial life on the right foot.
Fortunately, the Internal Revenue Service offers a number of deductions, credits and other tax breaks that have particular appeal to those in their 20s. With that in mind, let’s look at five of the most popular.
1. Take Your Educational Tax Breaks
Many adults in their 20s haven’t yet finished their education, so education-related tax breaks can be valuable. The American Opportunity Credit pays 100 percent of the first $2,000 and 25 percent of the next $2,000 in expenses for the first four years of college, maxing out at $2,500 per student annually. If your undergraduate studies are behind you, the Lifetime Learning Credit will pay you up to 20 percent of eligible expenses of up to $10,000, which can contribute another $2,000 toward your educational aspirations. Income limits apply, but with no maximum number of years that you can use the Lifetime Learning Credit, it pays to take full advantage.
2. Deduct Your Student Loan Interest
If your student loans qualify, you can deduct up to $2,500 in interest on your loans against your taxable income. Because the deduction is treated as an adjustment to income, you can claim this benefit even if you don’t itemize other deductions. The key is that you have to have taken out the loan to pay qualified higher-education expenses, and income limits apply.
3. Think Long-Term by Opening a Roth IRA …
When people think about saving for retirement, they usually gravitate toward traditional individual retirement accounts because those contributions create up-front tax deductions. But often, early in your career you are in the lowest tax bracket you’ll ever face, and so it makes more sense to look at a Roth IRA.
With a Roth, you won’t get an up-front tax deduction on your contribution. But you also won’t have to pay taxes when you withdraw money from your Roth in retirement. Given how much your investment can grow over that span of 40 or so years, the tax savings in the long run is well worth giving up the minimal deduction you’d get now.
4. … and get the Retirement Savings Contributions Credit as a Bonus
Another great reason to contribute to a Roth is that if you qualify, you can get the Retirement Savings Contribution Credit, also known as the Saver’s Credit. This essentially matches up to 50 percent of your retirement contribution in the form of a tax cut and is designed to offer an incentive to low-income taxpayers to start saving for retirement. With singles earning up to $30,000 and joint filers earning up to $60,000 being eligible for credits of between 10 percent and 50 percent on the first $2,000 to $4,000 saved, the Saver’s Credit is icing on the cake for smart planners.
5. Look at the Earned Income Tax Credit
In the past, the Earned Income Tax Credit was designed for low-income families. But more recently, changes to the law made the EITC available to people with no children, and now, singles making up to $14,590 and joint filers with incomes up to $20,020 can get the credit.
With a maximum credit of $496, the EITC isn’t the largest tax break available. But one particular benefit of the credit is that it’s refundable, which means you can collect it even if you otherwise don’t have any tax liability.
Motley Fool contributor Dan Caplinger remembers his 20s fondly. You can follow him on Twitter @DanCaplinger or on Google+. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.