posted on 06-06-2019

Deductible

Updated October 1, 2019

What is a Deductible?

In the finance world, deductible is usually short for tax-deductible, which refers to an expense that reduces the amount of income that is subject to tax.

In the insurance world, a deductible is a required payment from the insured to the insurer in order to trigger coverage.

How Does a Deductible Work?

For example, let's assume John Doe pays $10,000 for mortgage interest last year. He and his wife earned $150,000 from their jobs last year. Based on their circumstances, they can get a deduction for the mortgage interest (meaning they can deduct it from their taxable income). As a result, they must pay federal income tax on $150,000 - $10,000 = $140,000.

Anything that is deductible has a special financial value. In our example, if that mortgage interest hadn't been deductible, John Doe would have paid income tax on that $10,000 of income. If he's in the 28% tax bracket, that could amount to $2,800. Thus, the fact that mortgage interest is deductible saves him $2,800 in taxes.

Why Does a Deductible Matter?

When things are deductible, they lower a person's tax bill, which is why taxpayers invest time in seeking out deductions and structuring transactions to maximize those deductions. There are hundreds of different types of tax deductions, though some deductions are available only to people in certain income ranges (typically under $100,000 to $150,000) and most are available only to people in certain circumstances or companies in certain industries.