Whether you love it or not, the new tax bill is now law. Here's the best way to take advantage of it in 2018 (and beyond).
Forget all the news you've heard (or read) recently about the new tax bill. Forget the pundits on either side of the aisle that want to convince you that the world is going to come crashing down, or that everyone will be rich tomorrow.
All that noise only obscures the plain facts of the new tax bill and the enormous opportunity that Americans have because of it.
As a financial professional I work with people newly retired, nearing retirement, or hoping to one day retire accumulate assets, preserve assets, and protect assets. It's a job involving comprehensive financial planning, asset management, and budgeting. All of the parts have to work together to make sure someone doesn't outlive their money, among other things. But all this planning can be brought to a screeching halt for one reason: debt.
Nothing will derail a good financial plan like debt. Whether someone has just retired or is hoping to retire soon, debt will be the determining factor. Large amounts of debt will keep a person working longer. Debt will also hinder a person in retirement from doing the things they have dreamed of for 40 years. Debt is the most destructive force in a person’s financial life.
Reducing debt is the #1 way Americans can take advantage of the new tax bill.
According to a survey published by Nerdwallet, the average American household has $15,000 in credit card debt! That's just what is owed on credit cards per household in America. Nasdaq reports that the average American household owes a total of at least $139,000 in overall debt. Essentially, Americans are working longer and delaying retirement to pay their way out of debt.
With the passage of the tax bill, Americans have an opportunity to reduce their debt and better position themselves for financial freedom and some peace of mind. (True peace of mind can only be obtained by one means, but that discussion is for another article.) To take advantage of the opportunity that has been given to Americans, we have to understand how the new tax bill will impact our taxes.
According to this article at Investopedia, if you are married, filing jointly, earning between $75,900 and $153,100, you will see an tax reduction of $1,545 starting in 2018. Additionally, the income limit will be raised to $77,400 and $165,000; while the tax rate will be lowered from 25% to 22%. This means, if you earn between $77,400 and $165,000 you will see a tax rate drop from 25% to 22% and an overall increase in your tax return of $1,545.
(You can also read this article by Townhall Finance contributor David Bahnsen for an excellent overview of the tax bill)
Just to make it clear that this tax bill will be advantageous to most American households, Investopedia states:
“The Tax Policy Center says about 90% of middle-income households will have a lower tax bill, while 7% will have a higher one.”
Now you know most of us will enjoy lower taxes, which means more money in our pockets. So, what do we do with our returned taxes?
I suggest we develop a plan to pay down our debt.
First, let's be realistic, this won't happen overnight (or in a single year). Debt isn't acquired quickly and it isn't paid off quickly either. Debt is a result of spending habits that need changed. To be fair, some debt is not our fault, sometimes circumstances are beyond our control. But that doesn't mean we have to let the debt define or affect our future. Regardless of how the debt was obtained it requires a clearly defined plan to eliminate it.
Let me offer a very simple, yet powerful tool that will help guard against additional debt while reducing current debt (and savings): a budget.
As a financial professional I continue to be amazed at the number of families that do not have a formal budget to guide their spending. I continue to make clear that a budget is the first step in managing our finances well; which can lead to debt reduction and asset accumulation.
A budget really isn't difficult. It's simply a list of money that comes in each month (quarter or year) and then money that goes out. I teach people to categorize their money into three categories: have to, need to, want to. That is, things that “have to” be paid, things we “need to” pay, and things we “want to” pay for.
Examples of things that “have to” be paid are: mortgage, utilities, food, insurance.
Examples of things we “need to” pay for: an emergency fund, college fund, retirement account contributions.
Examples of things we might “want to” pay for: Netflix, gifts, entertainment, dining out.
Two of these categories are critical to our financial success (have to and need to). The things we “want to” pay for are not necessities and should only be funded once we have funded the other two categories. All three of these categories have some wiggle room. In other words, we need food, but we don't have to eat steak every night. If we aren't maxing out our retirement contributions but we are spending $8,000 on vacations each year, it might be time to reconsider.
The bottom line is debt will kill our ability to live generously, retire, and do the things we are passionate about. Now that we've been given some of our tax dollars back, let's make good use of them by getting out debt, saving more, and learning some financial wisdom that will positively impact our financial future.
For more information, read this article by The Wall Street Journal discussing how the tax bill will impact each sector of the economy.