Did you get the most tax savings possible this year? Is there anything you could have done differently that would have saved you more money? I bet there was.
You need to be proactive for big tax savings. By the time April rolls around it’s already too late to work the tax code in your favor. The only planning you have left is a last-minute IRA contribution before the deadline to salvage some savings.
Real tax planning is an ongoing process of making small financial changes that lead to big tax savings year after year. You need a plan for that and our extensive tax code offers up some places to start.
Make The Most Of Your Retirement Accounts
The biggest missed opportunity every year, that most of us fall far short on, is to not make the most of retirement accounts through work. With a retirement account, you get decades of tax-free growth with immediate tax savings.
Every dollar that goes into a 401k or 403b lowers your taxable income by the same amount. Put enough dollars in and you might drop yourself into a lower tax bracket.
But it doesn’t end there. Those 401k contributions lower your AGI and MAGI (adjusted gross income and modified adjusted gross income), which determines your eligibility for many tax credits and deductions. With a low enough MAGI you can take traditional IRA deductions too.
Not convinced? Test it first. Tax software lets you try before you buy. Go back to your tax return, only add a few thousand dollars extra to your 401k contribution. What type of credits and deductions can you get? How much savings could you get by putting more money toward retirement?
College Savings with a 529 Plan
Did you know you could use college as an excuse to avoid taxes? Instead of sticking money in a taxable brokerage account every year for little Susie’s college education, take a look at a 529 Plan.
A 529 Plan is basically an investment account for money set aside for the cost of college, with some tax benefits that go along with it:
- The college savings grows tax deferred.
- While money you put in is not tax deductible at the federal level, some states do offer a tax deduction.
- When it’s time to pay for college, the money is taken out tax free.
Imagine the tax savings on 18 years worth of invested college savings. In case you saved too much and there’s money left over, you can transfer the amount to your other kids or even grandkids, to put towards their college costs.
Start an HSA
Anyone with a high deductible health plan can open a health savings account (HSA) to help offset future medical costs.
There’s a tax benefit to doing this too. Any money you put into a HSA is tax-deductible, up to the annual limits. Better yet, the money can be invested, it grows tax deferred, and withdrawals for qualified medical expenses are tax free.
Give Tax-Free Gifts
There are several ways to lower your tax burden through simple generosity. Charitable donations are the most obvious for anyone who itemize their deductions.
But the federal gift tax has an annual exemption that allows you to pass money and your future tax burden to other people. When doing so, both you and the person receiving the gift won’t pay taxes on the amount.
The gift doesn’t have to be cash either. You can lower your income tax by gifting income producing assets, like stocks, bonds, or real estate, to other family members. Or you can avoid high capital gains tax by gifting stocks rather than selling the shares. Just make sure the people receiving the gift, are in a lower tax bracket.
Make Tax Smart Investments
A tax efficient investment plan is an easy way to lower your annual tax bill. First, you need to make the most of the tax advantaged accounts mentioned above. Then you put investments into the right accounts based on how each is taxed. The general rule is:
- Tax advantaged accounts – bonds, REITs, and any funds holding either
- Taxable accounts – stocks and tax-free bonds, like municipal bonds, and their fund equivalents
With taxable accounts, you can harvest capital gains and losses to lower taxes. Harvesting gains might seem counterintuitive, but if you drop into a lower tax bracket, with a lower capital gains rate, it offers a small opportunity to avoid a bigger tax hit in the future.
However, harvesting losses can have a big impact when used correctly. Each year, you can use capital losses to offset capital gains. And when you have no gains, you can use losses to offset your taxable income, up to $3,000 per year.
This is especially important to high income earners with the Medicare surtax in effect.
A World of Planning Potential for Retirees
Retirement is filled with multiple income sources – retirement accounts, pensions, social security, and investments. Each one brings new things to think about and taxes to plan for:
- Retirement accounts, like your 401k or traditional IRA, have required minimum distributions that kick in once you reach age 70½.
- When do you start taking social security? The longer you put it off, the more money you’ll get later.
- Does a Roth conversion fit into your retirement plan?
For new retirees, this can be overwhelming to manage at first. Your job is to find the right balance between taxable and tax-free income in order to keep your taxes low. And don’t forget to pay estimated taxes every quarter. Now that you’re retired, your employer won’t do it for you.
Don’t be Afraid to Ask for Help
The tax code is a confusing mess that doesn’t get easier as your financial situation improves. You can dissect every credit and deduction year after year or let a professional do it for you. It’s their job to understand the tax code and plan for any future risks you might face.
A good CPA or CFP will take a big picture look at your money, build a plan for this year, and the many years ahead. Just find one whose fees don’t offset all your savings.
Now is the time to start tax planning your future. You can put a plan into action that gets you more tax savings next year and the years ahead.