Greetings fellow fools. Please bear with a brief description of my current situation before I pose my question.I live in Florida with my wife and two children. We purchased our first home in May ($145K @ 8.5%) and have no other significant deductions.I have been offered a job that will start this month which will increase my income by $30K to a total of $68K ($55K salary, $13K annual bonus). My wife earns another $22K bringing us to a total of $90K.We are paying down $45K in consumer debt (not including home mortgage) and have no investments.How do I avoid getting killed in taxes? What is the balance between tax reducing investments and debt reduction?Thanks for the assist.Mike
We are paying down $45K in consumer debt (not including home mortgage) and have no investments.If the interest on the consumer debt is not in a deductible posture, you will want to arrange to do so as soon as possible. This is a rather large amount, and you probably would be well-served by being able to deduct the interest. I am sure some of the experts that frequent this page will fill you in on how to do it.
We are paying down $45K in consumer debt (not including home mortgage)I agree with the other poster: pay down the the consumer debt (not including home mortgage) as quickly as possible. In addition, try to avoid additional consumer debt. Depending on the interest rate, paying off the consumer debt could be your best investment. (The "Consumer Credit / Credit Card" folder has a number of participants who have or are paying down their cards and can suggest strategies for that.)How do I avoid getting killed in taxes? What is the balance between tax reducing investments and debt reduction?Do you or your wife have a "tax deferral" plan available at work, such as a 401(k) or 403(b)? If so, and if the expenses aren't horrendous, by contributing to such a plan your W2 salary (box 1) is reduced so your taxes are reduced. The tradeoffs are that you are penalized for accessing that money prematurely (except possibly as a loan) and when you retire and start drawing money it will be taxed at your ordinary income tax rates at that time you receive it. Usually this is a good deal for retirement investments.Mortgage interest can usually be used as an itemized tax deduction. (If the mortgage is for more than 100% of the fair market value of the house, only the interest for the part up to 100% of the fair market value can be deducted. There is also a limit on the size of the mortgage, so be sure to read the instructions for Schedule A or consult your tax professional.)The interest on home equity loans may also be tax deductable, again with a limit (I think it is $100,000) and even then only for the part of the loan that was secured by the equity on your residence. (E.g., if you get a loan for 125% of the equity you have on your place, that 25% is not deductable, I believe it isn't deductable for the life of the loan). Generally I don't like recommending home equity loans to refinance consumer debts (the tendency is to run up consumer debt again, leaving one with a far worse debt situation as well as putting one's house at more risk because then either the primary mortgage company or the home equity loan issuer can foreclose for non-payment), but if the interest rates are reasonable and one is successful in stopping the use of consumer credit, the interest of the home equity loan could serve as a good itemized deduction.I would recommend reading through the instructions for Schedule A to get an idea of what may be used as an itemized deduction. Even if you don't do your own taxes, the list will at least give you an idea of some things you can discuss with your tax professional or read up on in the "Tax Strategies FAQ" that you can click on while reading any message in this particular message area.A Roth IRA will help in your retirement years (the gains will be tax free if, for example, you had a Roth IRA account for at least 5 years and are 59.5 years old or older before taking the earnings out), but Roth IRA contributions won't help with current taxes.As far as what would give you the most bang for your buck, it depends on interest rates of your debts, what returns you could reasonably expect from your investment, your marginal tax rate. Taxes are one of the considerations, but one shouldn't let taxes dominate one's financial decisions.
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