How Taxes+Retirement Accounts Work & Why We Need to Minimize How Much Tax We Pay

Chris Haroun
A free video tutorial from Chris Haroun
Award Winning MBA Professor, Venture Capitalist and Author.
4.5 instructor rating • 54 courses • 1,029,738 students

Learn more from the full course

The Complete Personal Finance Course: Save,Protect,Make More

3 Courses in 1! Save,Protect & Make More! By an Award Winning MBA Professor, VC & Best Selling Online Business Teacher.

15:46:12 of on-demand video • Updated April 2021

  • Upon completion of this course, students will be able to save, protect and make much more so that their net worth is significantly higher in the long run. You will be a personal finance expert by the end of this course!
  • How to profit from the INCREDIBLE Power of Compound Interest
  • 100+ Ways to Save More…Including the following ways:
  • 14 Ways to Save More on Taxes
  • 16 Ways to Save More on Shopping Expenses
  • 13 Ways to Save More on Car/Transportation Expenses
  • 10 Ways to Save More on Housing Expenses
  • 5 Ways to Save More on Vacation Expenses
  • 4 Ways to Save More on Gifts & Donation Expenses
  • 6 Ways to Save More on Phone/Computer Expenses
  • 13 Ways to Save More on Food & Drinks Expenses
  • 7 Ways to Save More on Debt Expenses
  • 4 Ways to Save More on Education Expenses
  • 7 Ways to Save More on Entertainment Expenses
  • 6 Ways to Save More on Fees Expenses
  • 5 Ways to Save More on Child/Child Care Expenses
  • 4 Ways to Save More on Health Expenses
  • 5 Ways to Save More on Personal Care Expenses
  • 5 Ways to Save More on Pet Related Expenses
  • How to Change Your Perception of Money
  • How to Teach Your Children About Saving
  • How to Protect Your Money by Understanding Your Net Worth (Creating and Understanding Your Balance Sheet….Meaning “What You Own and What You Owe”)
  • Understand if You Should Hire a Financial Advisor to Help Protect Your Money
  • Understand Why Hiring an Accountant Might be the Best Investment You Might Ever Make
  • How Taxes + Retirement Accounts Work & Why We Need to Minimize How Much Tax We Pay
  • How Much You Need to Retire
  • Understand and Taking Advantage of Tax Incentives, which Help You Save BIG TIME for Education/School Expenses
  • How Much You Need for Education Expenses (for You or Your Kids)
  • How to Create Your NEW & IMPROVED Income Statement (Meaning Understanding Money In and Money Out)
  • Understand Your Company Sponsored Tax Savings Plans (if Applicable)
  • Use a Simple & Effective Money, Taxes, Receipts and Statements Filing System
  • Understand What are the Best Websites & Apps to Help You Track and Manage Your Spending
  • Use Quicken on a PC to Manage Your Money
  • Use Quicken on a Mac to Manage Your Money
  • Protect Your Money by Making a Monthly Budget
  • Avoid Getting Ripped off on Fees
  • Understanding Wills and Trusts
  • View, Understand and Fix Your Credit Score/Rating (So You Can Get a Loan or Mortgage)
  • Understand Life Insurance
  • Understand Auto Insurance
  • How to Pay Less Tax Strategies
  • Understand Home and Property Insurance
  • Understand Health Insurance
  • Prevent Identity Theft
  • Understand Credit Cards
  • Understand Loans
  • Understand Leases
  • What Are the Qualities of Billionaires (5 Characteristics of Billionaires I Have Worked For)
  • Understand the Damage that High Investment Fees Can do to Our Net Worth!
  • Make More by Learning How to Avoid Paying High Investment Fees
  • Understand Why and How to Pick Investments from Index Funds
  • Manage Your Investments with Your Investment Portfolio Management System (Included in the Course)
  • Populate Your Investment Portfolio Management System (meaning Your Portfolio)
  • How to Invest in Stocks and 4 CRUCIAL Stock Investing Rules
  • Investment Data Basics
  • Understand Risk Management
  • Understand What Makes Stocks, Bonds, Commodities and Real Estate Investments Go Up or Down
  • How to Do Your Own Investment Research (and Never Rely on the “Pros”)
  • Understand Mutual Funds
  • Know What Warren Buffett’s Favorite Types of Investments Are
  • Understand Interest Rates, Bonds and “The Bigger Picture”
  • Know How Global Economics Works and Why this Matters to Personal Investors
  • How & Why Do Interest Rates Change & Why this is Important for Investors to Understand?
  • Understand Foreign Exchange Currency Movements
  • How Bonds Work and How Can Governments Stimulate the Economy?
  • Understand Real Bonds - No Theory! (With Real Corporate and International Government Bond Investment Examples)
  • How to Invest in Bonds
  • Add Bond Investments to Your Portfolio
  • How to Invest in Commodities
  • Add Commodity Investments to Your Portfolio
  • Introduction to Your Most Important Personal Investment & How Much Should to Spend on a House
  • How Mortgages Work & How to Calculate Payments (Fixed Rates Versus Interest Only Rates & More)
  • How to Calculate Mortgage Payments and Know What Happens When Rates Change
  • What You Need to Know if Considering Investment Properties
  • How Much to Spend on an Investment Property
  • Understanding Real Estate Investment Trusts
  • Adding Real Estate Investment Trust Investments to Your Portfolio
  • Investment Types to Consider Avoiding Given Liquidity Risks
  • Diversification Strategies and Your Diversified “Model Portfolio”
  • Should You Start Your Own Business & Have >1 Income Stream? 100% YES!
  • Customize Your Own Complete Personal Finance Excel Dashboard (I Will Teach You How to Customize and Create Your Own Version of the Excel Dashboard Document Used for ALL 25 Exercises in this Course)
English -: It's almost impossible to save money unless you understand the awesome tax advantage of retirement savings programs and other programs as well. And there's so many taxes in many countries like Federal tax, State or Provincial tax, sales tax when you buy something, property tax, which can be 1% of the value of the property you own, et cetera, and State taxes, higher taxes on the wealthy, et cetera. And every country and state or province has different tax rates. And if you take all the taxes that you pay, then the percent of taxes that you pay can be close to or more than 50% of your income which is crazy. And this means that you sort of end up working for the government for more than six months every single year. You know, from July to year end you work for yourself, kind of. So, or you make money for yourself, I should say. So this is why you need to do anything we can within the law, of course, to minimize how much tax we pay. As this is by far our largest expense, taxes that is. So, let's say you make $50,000 annual income and on that $50,000 you're supposed to pay 20% tax. This means you're left with $40,000 after tax. Hold on a minute, please. Many countries let you deduct now your retirement savings that you contributed that year, so the amount of tax decreases. I'll give you an example. So, let's say that you contributed $10,000 that year to your retirement fund. Then this means that you're only gonna be taxed on $40,000 and not $50,000. So the amount of tax that you pay is $8,000 and not $10,000. Yes, you saved $2,000 in taxes right there. It's a huge deal, okay. And we know that beautiful power of compound interest from exercise one of this course. And so it's absolutely crazy not to take advantage of this tax benefit every single year. Okay, and every country's a bit different. But you need to max out on your annual retirement savings benefit or you're literally, literally throwing money in the garbage, okay. And to learn more about tax shelters like retirements and more in your country, please see the gray shaded box in the settings tab here for this video, okay. Separately, let's drill down a bit more on the income tax calculations. When you calculate your income tax rate, in many countries, there's what's called a step function. And I wanna explain to you how it works. Every country and region and year and government creates and changes tax laws a lot, which is why I hired an accountant, of course makes sense, as their job is to make you pay less tax. But I wanna give you an example of how income tax works in most countries of the world. And again, these numbers will change constantly and the tax rates. So here's the step function example. Between $0 in income and 10,000, you pay 10% tax. It's just an example. Then for the amount you make between $10,000 and $30,000, you pay 20% tax. Then for the amount you make between 30 and $50,000, you pay 35% tax. And then the amount you make over $50,000, you pay 45% tax. Okay, so, if somebody makes a million dollars using the aforementioned hypothetical tax rate example, they would pay taxes as follows. They would pay $1,000 tax on the first $10,000 they made. Then they'll pay $4,000 tax on the amount they made between 20K, or they made between 10K and 20K. Okay, so that's a total of 5,000 so far, okay. Then they pay 35% tax on the next 20K, meaning seven grand in taxes for a total of $12,00 so far. Then 45% they'll pay on the next $950,000 in taxes, right. So 45% of $950,000 is $427,500, okay. So let's add the 12K in taxes to this $427K, roughly amount. So the total that person making a million dollars would pay in taxes is $439,500, which is 43.95% tax on income of a million dollars. Okay. Now there are other tax deductions that you can get if you have dependents or kids. And if you work for somebody else, then at the end of each year you will receive a tax document that highlights how much you've paid or should be paying in tax. Okay, in the United States, this tax document they give you is called a W-2. And if you work at a bigger company, you can always call human resources to have them explain the process to you. Okay, so, to see what documents like W-2 you need to file in your country, please click on this link here on your tax filing organizer tab, and see the internet links in rows, I think it's 37 and 39 here, okay. And we're gonna cover a lot of the other stuff on this tab here in exercise number 13. Now, I want you to have your company deduct as much money as possible every paycheck to go into your retirement savings account so that your taxable income is less. And remember when I explained the difference between filing and showing, like you're making 50K versus 40K, remember that $2,000 in savings, 'cause you pay less taxes? That's what I'm talking about here. So in every country the dollar amount or currency amount you can put in your tax free retirement account is different, okay. It's your money grows tax free in this account until you take it out much later in life. It's a beautiful thing. And so as of now, and I promise you this will change. The most you can put into your retirement account every year in the United States tax free is $18,500. Your retirement tax plan in the U.S. is often referred to as a 401(k) or in Canada it's called an RRSP. In England it's the PPP. And in Australia it's called the Superannuation. And in other countries there's other names as well. You can learn more about your country's retirement programs, if available, by clicking on the links, again, in the gray box on the settings tab here or in the tax filing organizer tab, I included it as well in that box, okay. I included the same in a couple of places just to make it convenient for you. Okay and so, although other countries have different names for this concept, the concept of tax deductions, meaning saving money now tax free, and then paying taxes on the saved amount later in the future is similar. The different names, but the whole concept is similar. You pay taxes much, much later, not today. So do a search in your country on the retirement savings program name if it's not here in this box. And a 401(k) in the U.S. means a company sponsored the retirement plan, okay. And you don't pay taxes on the $18,500 maximum contribution to your 401(k) until you take the money out years in the future when you retire, okay. And the problem is, though, that we have no idea what the tax rate is going to be many years in the future. And just given the amount of debt many countries have, just please assume that the future tax rates could be a lot higher than they are today. Okay, I just want you to be conservative, that's all. And every country has different retirement saving contribution laws, if applicable, and your company's human resources department will help you out with this. If you have one, call HR, and they'll walk you through the steps of how to contribute to your retirement account, so it's taken out of your bank account every month, okay, or out of your paycheck even, right, before your company pays you. Many companies will even match every dollar or a large part that you contributed to your retirement account. And so talk to your employer to see if those programs exist. And if they do exist, please do whatever you can to take advantage of this as it's literally free money, literally, okay. And don't focus on relying just on a pension plan if you even have one, please. Especially if you're younger and your a Millennial, because Millennials are likely to work for many different places at the same time and have many different sources of income as the sharing economy gets more, more, and more relevant. Kind of like driving an Uber while you work at part time for a company while you rented a room to AirBnB, that sort of thing, okay. Your parents might have had a pension, but if you're under 30, you most likely won't have one. Now, if you don't work for a company that offers a 401(k) or retirement plan, there are likely other government savings plans that you can contribute to for your retirement, which is called an IRA, in the United States, which stands for Individual Retirement Account. Similar to a 401(k), the IRA won't be taxed until you take the money out when you retire or later in life. So how does all this work? Well, this is a tax form for the United States, okay. And I got this from my library. You can go online and they'll mail it to you as well, the government, okay. And here you can deduct certain items for the amount of income that you're documenting on your tax form. So like you pay income tax, not on your income, but on your adjusted gross income for this form, adjusted gross income. Now, as a separate side note, some countries actually let you put money into your retirement account today, but you pay taxes today and not when you take it out, okay. And this is kind of the opposite of what we just talked about in the United States. In the United States, they actually have a program like that called a Roth IRA. And the good thing about paying taxes first and then contributing, meaning putting the money into a Roth IRA, for example, in the U.S., is that if you think taxes are going to be much, much, much, much higher in the future, or if you think that the tax rate will be way higher on you for whatever reason, then making these pay tax first or Roth IRA accounts, as they call it in the U.S., is a good idea. And there are limits, though, on Roth IRA and non-Roth IRA contributions. And the IRA limit is about $5,500 or a little bit higher if you're older than 50 years old. And you gotta make less than $160,000 individually to do this or $183,000 as a married couple. And I promise you that these amounts will change as the tax code frequently changes every single country. And so please read government tax-related website contents as I put here for your country, as they're often not as complicated to read as you think they are. And just spend time and get a big cup of coffee first off, or actually what I like to do is I drink this diet Mountain Dew, it's actually high in caffeine, anyway. Sorry, off topic. Okay, I'm not sponsored by Mountain Dew. So spend time reading these websites and if you don't understand them, you can talk to your accountant as well, okay. Because I want you to pay as little tax as possible, okay. And these websites can put you to sleep though, they're kind of dry, okay. --, now the IRS is gonna audit me for that comment. I don't care, okay, I just wanna do whatever it takes to help you protect your money, that your family's taken care of. So ask your accountant that's filing your taxes if there are any tax credits that you can take advantage of, and if there's any way to reduce your taxable income in the next 12 months, meaning retirement savings programs, et cetera, okay. It's the accountant's job to understand the changing tax codes, not yours, and not mine, we just don't have the time, right. And so hiring an accountant can cost as little as 20 bucks in some countries to several hundred dollars or more in other places if you have a complicated tax profile. But it's really worth the investment for you, okay. And if you're uber, uber wealthy, you're obviously gonna pay thousands and thousands of dollars, tax lawyers and all that stuff. But they'll save you money as well, okay. And if you don't want to hire an accountant, then you can use online tax preparation software, which I don't recommend, but you can do it. An example is TurboTax.com. Or you can go to your government tax website, for example, irs.gov in the United States, and search for the words free file. And I actually have an older form here, this is from 2016 for the United States, we the people and it's, they'll tell, there's free file, it's irs.gov/freefile. And this is anyway a tax document. Not as hard to understand these things as you think, especially after what you learn in this course. I humbly hope, okay. And so, many larger accounting companies, actually, will even let you file your taxes for free using their websites and their software, okay. But they'll really try to upsell you and get you as a paying customer, if you have more complicated tax returns, et cetera, okay. And I know I keep mentioning this, but I want you to find a way to hire an accountant, because I really care, and I want you to pay less tax. And I want you to take advantage of all these beautiful tax incentive plans. And if you don't, you throw money in the garbage. And also by hiring an accountant, they'll hopefully keep you within from breaking the laws, because tax evasion is actually a felony, and jail time and huge fines occur by not paying taxes. Even if you paid too little by accident, even if it was an accident, it's still a felony or can be. And people, this is crazy, man, this is gonna blow you away. But in many countries, most countries, people can report you, okay, anonymously, like former friends or people that are jealous because you're doing really well now, right. And they can report you to tax agencies. They do this, it happens a lot, it's true. In many countries, like here in the United States, your buddy, your friend, or your neighbor can literally call the Internal Revenue Service, meaning the tax agency here, and anonymously report you. It's crazy, I know. But there's a lot of celebrities that have gone to jail as well and other criminals as well. Obviously Al Capone is one example. He actually went to jail here in San Francisco, there's an island that's actually a jail here. And he went to jail because of not paying enough tax. And a bunch of celebrities have gone to jail as well. And in many countries, people actually get rewards for turning in friends or employers, et cetera that cheated on their taxes. And you know, sometimes these rewards are literally in the millions of dollars. So who should you hire as your accountant again? You talk to your friends and family, whatever, they'll tell you who to hire. But I want you to grab a coffee with at least one accountant before you hire them and that was recommended to you, and just ask them what kind of tax deductions you might be able to receive and ask them for the price they offer, et cetera, first. And your friends will tell you if their accountant has helped them get big refunds in the past, and that sort of thing. It's almost always an incredible investment as you can actually get a tax refund a lot of times by hiring an accountant. And it keeps you from not filing taxes properly, which can get you in a lot of trouble. As we know ignorance of the law is no excuse. And when you hire an accountant, or this accountant, be sure to tell them if you ever lost money in the past on investments as you might be able to carry forward this tax loss situation I've been talking about before. We spend a fortune on doctors to help us heal and often the health issue is created partially because we incurred too much money-related stress over many years. And so, I think that hiring a great lifelong accountant can actually save you money, because our money issues might be less severe under the tutelage or help, I should say, or advice of an accountant that can stop us from buying investments that contain red flags, et cetera.