Effective Tax Management with Saving and Investing
There are different types of tax: income tax, property tax, and local government tax. Understanding these is an important step to improving your financial literacy.
Each country has its own tax rules, tax rates, tax return forms and requirements.
Accountants are helpful in assisting with filling in tax forms, in countries where online management is not possible. However it is important to know what questions to ask, what information is critical, what paperwork (as evidence for submission) is needed so that filling in tax forms is a smooth and strategic process.
Strategic is a key word here, because it determines how income is optimized, how money deductions can lead to savings and good investments for retirement.
It is useful to understand how the tax system works in the country where you earn and declare income. Terms such as pre-tax and post-tax income are key to financial planning.
A key question would be what determines income?
o Salary or fees earned monthly/annually
o Rent from real estate investments
o Alternative sources of income (sale of assets)
Taxable income is the amount of income on which we pay taxes, therefore the net income that comes to the bank account is the post-tax income.
On top of the deductions for tax, there are other deductions on the paycheck, such as social security, national health insurance, or other similar taxes. The post-tax income should also reflect these deductions.
- It is important to know the % of tax deduction for each of these contributions.
The Basics when Filling in a Tax Form
When filling in the tax form, identify which expenses or income are not taxed. Example of income not taxed could be money saved for retirement, or for medical insurance, or child support payments. Some discounts may include pension fund accounts and money that are put aside for an employer sponsored account such as health savings or pension savings account.
Some governments offer incentives to save for retirement, and the government offers tax benefits such as tax deferred savings accounts. However, worth to note that tax deferred accounts only postpone payment of taxes. Eventually tax is payable when funds are withdrawn. But in the meantime, these pension funds enable money to be invested and grow to a point where earnings potentially are more than the future tax amount.
The key here is to save and invest income so that the taxable income is optimised.
What is a Progressive Tax System?
A progressive tax system applies different tax rates to different levels of income. There is a minimum amount at 0% and as income grows the tax rate grows, bracket by bracket. For example the first 15k would be taxed at 10%, then between 11k -30k the tax would increase to 12% and so on.
How to Reduce Taxable Income
In summary to the above, the key is to save and invest income so that the taxable income is reduced. How? To attribute amounts of income monthly/annually towards:
- Savings and investments in pension fund or retirement contributions
- Health savings accounts
- Health insurance
- Pension contributions
Even if this means a reduced end of month pay, consider that in 20, 30 or 40 years or at retirement age, these amounts of money would be worth more, if contributions are at the maximum allowing money to grow. One can say it is “forced’ savings.
It would also mean that learning more on saving and investing is a must in order to track the performance and the value of money saved and invested.
Make a promise to contribute towards retirement and to learn more about saving and investing to increase the value of your hard-earned money.
Two More Points on Property and Municipality Taxes
On property tax it is important to understand what determines property and which type is eligible for tax (residential, industrial, agricultural). Premium property locations usually carry higher tax brackets. This is an important consideration when buying property as principal family home or as investment income.
On municipality tax, this is deductible on the size of the property, or the region, municipality the residence/real estate is located. Municipality has different layers of taxation that cover the welfare of the neighborhood (waste, climate, infrastructure, water).
A Final Note: Tax Payments and Forward Looking Cash Flow
When looking at annual tax expense, identify the months that payments are due, and a plan savings pot for these. Creating a big expense on cash flow (either in December holiday month or in September when school expenses are at a peak or when a holiday is planned) on needy months is not helpful.
Plan, save for tax payments, and let forward looking cash flow help effectively. Check our model forward looking cash flow, ready for ease of use, right on our tools page.