Video: How To Reduce Taxes

How To Reduce Taxes: Pay Taxes Like the Rich

Do rich people pay a smaller percentage of taxes on their income than you do? Probably. Learn how to reduce taxes so you pay less too. 

It doesn’t make good financial sense to pay more to the IRS than you have to. There are plenty of ways to reduce the amount you pay in taxes–from itemizing deductions to saving for retirement. Pay taxes like the rich by strategically (and legally) reducing your tax rate.

How to Reduce Taxes Video Transcript:

You may have heard talk recently about how sometimes, extremely wealthy people manage to pay a smaller percentage in taxes than hardworking Americans do. While you may not be wealthy yet, there’s nothing wrong with trying to minimize the amount of taxes you pay on your hard-earned income. One of the best strategies I can recommend is to open and contribute to a Roth IRA.

A Roth IRA is a type of savings vehicle that allows you to have tax benefits later in life, when you retire. Those benefits are that you contribute money today with after-tax dollars. Meaning if you contribute $5,000 to your Roth IRA today, you pay taxes on it based on your current tax rate.

So, let’s say that rate is 20% just for point of example. That will of course depend on where you live and how much you make. If you pay $1,000 on that $5,000 today that’s a 20% tax rate. Now, fast forward 20 years and if you’ve earned 6% investment return overtime on that $5,000 you contributed, it will grow to be worth over $16,000. That’s pretty good, right? It’s great anyway. But even better is that you will never pay taxes on that money again.

You’ve already paid $1,000. And if we apply that $1,000 tax bill that you paid on your now $16,000 that you’ll have 20 years from now, we can get you down to a tax rate of just 6.25%. Now that is how to pay taxes like the rich.

Disclaimer: If you are single and will make more than $110,000 in 2012 OR you’re married, file taxes jointly and will make more than $173,000 in 2012, read more about how you can apply this tip here (from Forbes).