Are Deductions Still Worth It?

“Hey Mike, people always talk about deducting their expenses. Is it really worth it and what counts for a deduction?” Discover the reality of deductions, your tax returns, and how you may want to approach your tax strategies in the future.

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What is How to Retire on Time?

Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.

Mike: 00:05

Welcome to How to Retire On Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice. This show's about getting to the details so you can determine what is right for you. My name is Mike Decker. I'm a licensed financial adviser and fiduciary.

Mike: 00:18

With me here is David Franson. He'll be reading your questions, and I'm gonna do my best to answer them. As always, text your questions to [phone]. David, let's begin.

David: 00:28

Hey, Mike. People always talk about deducting their expenses. Is it really worth it, and what counts for a deduction?

Mike: 00:36

Yeah. So let's talk about a dear friend of mine, a CPA. He calls it the four flavors of tax. Oh. This is important.

Mike: 00:42

Okay. Flavor one. What is it? Yeah. Flavor one are tax credits.

Mike: 00:47

So not a deduction, a credit. A credit is a dollar for dollar off your tax bill.

David: 00:52

Yeah. So this is like you're getting money back, or if if you owed a certain amount of money, this credit reduces what you owe.

Mike: 00:58

Yeah. So let's say your taxes, easy math, $10,000, and you have a $5,000 tax credit, you just take $5,000 off the tax bill. Nice. That's the that's the simple explanation.

David: 01:07

Okay? Credits are what you want. We like credits.

Mike: 01:09

If you

David: 01:10

can get them.

Mike: 01:10

You can it's hard to get them. Okay? And usually tax credits come at a high price. There's a reason why they're credits.

David: 01:16

Like you have to have many children?

Mike: 01:18

No. Those are deductions.

David: 01:19

Oh, really? I thought put a little child tax credit.

Mike: 01:21

Yeah. I guess the credit there. Yeah. I stand corrected on

David: 01:24

that Thank you. But anyway But that

Mike: 01:26

well, it's that one's changing because of the one big beautiful bill. Oh. So that's why I say there's Always changing. There were there were some deductions based on if dependents, and there were some on if they were your children. So things have shifted in that department.

Mike: 01:39

So look into that a little bit more. But tax credits, dollar for dollar.

David: 01:42

K.

Mike: 01:43

K. Great. Off your tax bill. The next one is the deductions. K?

Mike: 01:48

K. So if you deduct something, it means let's say your your tax rate's 20%, your effective tax rate, or or your whatever the the deduction rate is. Basically, it's if you spent $10 for every dollar you spent, you can deduct 20¢ off of it.

David: 02:06

Okay.

Mike: 02:06

Because you're not saving money. You're not getting money back. It's just you get a little bit back of what you spent.

David: 02:12

Is that reducing your taxable income just fractionally?

Mike: 02:15

Or Yeah. Okay. Like, when people say, oh, just deduct this, and it's fine. Yeah. Okay.

Mike: 02:19

You're just spending 80¢ on the dollar. You're still spending money. So don't think that you can deduct your way out of losses or out of spending. That's just why I think it's kind of a funny situation. Right.

Mike: 02:29

Now back in 2016, the deductions the standard deduction was low, and so a a lot more people would itemize their deduction. When you itemize your deduction, that's when you're saying, okay. Well, hey. You know, I I did a lot of charitable contributions. I did a lot of these other things, a lot of business expenses.

Mike: 02:47

I can itemize the deduction. And so if I get 20¢ back on every dollar I spent, that's a greater benefit to me than just taking the standard deduction. But with the standard deduction today being so high, most people I think it's, like, 90 plus percent of people just take the standard deduction. So in that situation, it's like, yeah, you could deduct the expense, but you'll have less tax benefits when you file than you would if you just take the standard deduction.

David: 03:16

Yeah. So you might wanna look at when you do taxes, total up all of your, you know, itemized and see if it's greater than the standard, and and now maybe it's not for as much

Mike: 03:25

as though. Many times it's not. It's like people say, well, hey, don't you wanna get all these bills? I'll say, well, are your bills or the the things you can deduct greater than this amount? They'll say, no, not even close.

Mike: 03:35

Yeah. So for those that are charitable or or could be kind of near the threshold, typically, I like to see is that they'll do all of their itemizations, the itemized deduction transactions in one year. So maybe in January and December is when you do your charitable contributions, you're doing your donations, you're taking it to the the thrift store, whatever it is. But you do that all in the same tax year. So in one year, you do the itemized deduction, and then the other year, you do the standard deduction.

Mike: 04:05

You can kind of go back and forth.

David: 04:07

I see. Interesting. So that's flavor two?

Mike: 04:09

That's flavor two.

David: 04:10

Okay.

Mike: 04:10

Flavor three, this one is deferral, tax deferral. Oh. So your four zero one k, when you defer taxes, you defer income tax.

David: 04:18

Oh, right.

Mike: 04:19

What you're doing is you're just saying you're gonna pay it later. So your IRA, you've deferred taxes to be paid at a later date. That is a benefit, but it's also a detriment because if tax rates go up in the future, if your account gets very, very large, RMDs, there's a lot of things that could blow up in your face. But overall, it's a pretty good benefit if used appropriately and is in balance with your other tax accounts. So you got IRA or pretax that's qualified.

Mike: 04:45

So it's a retirement account. It's not subject to capital gains. It just grows tax free, but you're gonna pay taxes in the end. Then you've got your tax free account, which that's the fourth flavor of the tax. It grows tax free, and it pays out tax free.

Mike: 05:00

So that's just tax free. Yes. Grows tax free, pays out tax for your Roth IRA as an example of that. And then you've got your brokerage account. So it's subject to capital gains.

Mike: 05:11

If you trade it, you're gonna pay some sort of tax, whether it's short term or long term capital gains. But, yeah, those are kind of the four flavors of taxes people need to be aware of. You've got, again, tax credits, dollar for dollar. Great. Great benefit.

David: 05:22

Get those if you can.

Mike: 05:23

Tax deductions, you're getting a percentage back on what you spent, but you're not gonna deduct yourself into profits. Then you've got your tax deferral. You're kicking the can down the road, And then you've got your tax free, which is Roth IRAs, life insurance. If you borrow against the policy, also qualify for that as well.

David: 05:41

And then and are there some, like, municipal bonds or something that are

Mike: 05:44

The interest on the municipal bonds, it's it's tax free.

David: 05:47

Okay.

Mike: 05:48

Yeah. But not all tax free, like municipal bonds, qualify for certain benefits. So your municipal bonds could disrupt your Social Security taxes. Your municipal bonds could disrupt your modified adjusted gross income, which could affect your new senior deduction. So it's a very complicated situation, but the moral of the story is don't spend money thinking you're gonna get it back through deductions.

Mike: 06:11

That's not a real situation, And expect that most people are going to take the standard deduction. So don't be like, well, I can deduct this. You're probably not gonna deduct it. Most people in retirement don't really do many actual itemized deductions. It just doesn't make sense for them.

David: 06:27

Okay. So the answer to this question then is, is it really worth it? Probably most of the time not?

Mike: 06:32

Probably not. If you've got a business or a special situation, seek a tax professional that can break it down. We're happy to break it down for you as well. But all in all, it's just assume that you're gonna take the standard deduction unless proven otherwise. Still look into it.

Mike: 06:47

There's always an exception to the rule. Maybe you're the exception to the rule, but don't just assume that you are. Trust but verify. Assume but verify. That's all the time we've got for the show today.

Mike: 07:00

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Mike: 07:26

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