Tax Savings As An Investment Banker: Good Luck
So if you’re like me some fellow investment bankers out there, you may have woken up today and said, “Tomorrow… is April 15! What do I do about taxes?”
I’ve seen a few questions floating around lately on tax savings as an investment banker, especially for Analysts and Associates. Unfortunately there isn’t a whole lot you can do if you’re a recent graduate, earn a high income, and have minimal expenses.
That doesn’t mean you can’t try, though.
The Problem
The basic tax problem as a newly minted investment banker is that you’re making a lot of money from a job (as opposed to making money from a business, from dividends/interest and/or other sources of income), but you have little in the way of other expenses.
Your main expense will be apartment rent, and there’s no way to save on taxes there (unlike with home mortgage payments). Food is paid for by your firm; even if it weren’t, you still couldn’t deduct it because it’s a basic living expense.
You can’t deduct any models and bottles type expenses, and anything like transportation or travel expenses will either be covered by the firm or not deductible. Since you don’t own a business, there’s not much room to be creative with expenses.
The Half-Year Stub
If you just started working in the summer this past year, the half-year stub will be your best way to save on taxes. As an Analyst you will have only made around $30K, so you will get a huge refund.
As an Associate, the refund won’t be quite as large because you’ll be in a higher tax bracket anyway, but you’ll still get something.
If you stay in finance long-term, this half-year work period will be your lowest-income year, so take advantage of it.
The Myth Of Student Loan Interest Tax Savings
People often point to student loan interest deductions as one area for possible tax savings. The only problem: you can’t actually save much on taxes from student loan repayments:
- Interest is only deductible up to $70,000 in income – so this deduction goes away after your first calendar year of work (the only time period when you make less than that).
- Most student loan repayment plans require both principal and interest payment. Principal repayments are not deductible, so if you decide to go for the tax savings in your first half-year, make sure you’re paying off the interest.
- Even if you are eligible you can only deduct $2,500, so the tax savings is not tremendous.
While you can and should use student loan interest deductions if you can do so, it won’t save you a ton of money.
Retirement Plan Savings
This is another area where people always claim you can save money. Unfortunately, the truth is not so simple.
First, your Roth IRA eligibility vanishes after your first half-year of work when you make way too much income to qualify. While the Roth IRA is a great tax shelter, it just won’t be applicable for very long unless the market truly tanks and bonuses drop to $5,000 across the board.
If your firm offers a 100% match on the 401(k), it’s a really good deal both to save on taxes and get free money for retirement savings. Even with a lower percentage match, you still get some amount of “free money.”
If you’re investing a lot of your money anyway, retirement plans can be a good way to save on taxes. Just don’t make the mistake of using them solely to save on taxes. If you need the cash flow more than the tax savings, don’t put the maximum amount in a 401(k).
Extreme Tactics: Buying A House, Getting Married Or Injuring Yourself (Medical Expenses)
If you are obsessed with saving money on taxes, there are a few extreme tactics you could try: buying a house, getting married or racking up high medical expenses.
Buying a house lets you deduct mortgage interest expense no matter what your income level is, and if you own rental properties you can deduct maintenance expenses.
Unfortunately, as an Analyst you probably won’t have enough money for a house, especially if you live in New York. And with the subprime mess these days, you actually need a down payment for a house. 
Getting married is another possible way to save on taxes, since you can qualify for deductions that you were ineligible for previously and since the same income level is subject to a lower tax rate if you file a joint return.
As an entry-level investment banker, you will be somewhat constrained in your attempts to find a marriage partner. With about 5 hours of free time per week, your options are limited to a) office romance or b) importing a husband/wife. Neither is great, but b) is probably better from a career perspective.
If you have enormous medical expenses, that can also be a possible deduction. But injuring yourself purposely or claiming more than you really paid are not great ideas to try here.
Living Abroad
If you’re an i-banker from the US working abroad, you get hit with a double tax since the US government taxes citizens living and working abroad. While there are ways to get out of it or reduce the burden, it’s generally a pain to deal with. And if you’re a foreigner living or working in the US, I don’t even know where to start. Your situation will be complex, to say the least.
So, What Should I Do?
First, remember to actually file on time… it’s easy to forget with everything else you have to do. If you do have any unusual expenses like mortgage payments, medical bills, etc. consider itemizing and using them. But don’t go overboard here… if it doesn’t apply to you, it doesn’t apply.
In all likelihood, you will end up owing tax money if you’ve been working over a year – that’s just the way the system usually works if you have minimal deductions.
Note that I did not discuss charitable contributions at all here. That’s another area where you can save money, but since we’re talking about investment bankers here, I didn’t think it was applicable.
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I’m not 100% sure about the correctness of this, but I read in a NYC relocation guide that you can deduct moving expenses on your taxes. So, first-years should be able to deduct all the flights, moving trucks, and other move-in expenses that they incur when they move to New York.
David, I think that’s true but don’t think that holds if the firm covers your moving expenses… think it only applies if you pay for everything yourself. Still, a good way to save on taxes if they don’t cover those expenses for some reason.
Two things I wanted to point out
1) In the Retirement Plan Savings: I believe the IRA you mean to refer to is the Traditional IRA and not the Roth IRA. The contributions to the Roth IRA are after-tax dollars so it cannot be a tax shelter since taxes have already been paid on the contribution. The Roth IRA is essentially a shelter to future tax increases by the government (since the tax has already been remitted at a lower rate). Meanwhile, an after-tax contribution to a Traditional IRA is tax deductible in essence converting the dollar contribution back to pre-tax dollars thereby reducing overall tax liability. Like I said, I believe you meant to refer to the Traditional IRA. (There are other reasons for a Roth IRA that I do not mention since they do not pertain to the topic of tax shelter)
2) In the What Should I do: You say “In all likelihood, you will end up owning tax money if you’ve been working for over a year – that’s just the way the system works if you have minimal deductions” This is actually a false statement. When you file your W-4 at the beginning of the year, the withholding rate from the W-4 attempt to accurate mirror the tax liability a tax payer should actually owe at the end of the year. Of course, in a perfect world, the W-4 withholdings would be a perfect proxy of actual tax liability and when everyone files their taxes, they will find out that they paid exactly the right amount over the course of the year. Of course, we do not live in a perfect world and so this situation of the right amount paid over the year rarely occurs. The deductions at the end of the year (if you itemize or receive extra deductions like school interest payment), change in withholding rate due to a one-time bonus paycheck, life events changes (such having a baby (extra deduction) or marriage(wider tax bracket)), dividend interest, and/or capital gain skew the number one way or another. Nonetheless, the system is designed to try to be an accurate proxy of our tax liability and then once every year (the year after of course), we get to reconcile the number and bring order to the world. If you have any deductions, no matter how many, you should receive some income back from the government for overpayment (this is contingent on the fact that a proper W4 allows the government to have withheld the right amount). Trust me; the government wants their money earlier rather than later.
That’s enough rambling from me. Good past overall. Keep up the good work.
Shane, very thorough reply – thanks. Yeah I think I might have been off on the IRA, but with either one your eligibility goes down as income goes up so not applicable for bankers unless they’re still in their first year.
And the owing money comment was based on most of my friends in banking (including myself) owing money in their 2nd years onward. No real scientific explanation for it, think it’s mostly because of that large one-time bonus payment.