Tax Season Got You Down? Here’s How You Can Reduce Next Year’s Tax Bill
By the time tax season begins, it is too late to employ many tax reduction strategies. That’s why it’s important to have a financial plan that works year-round to minimize your taxes. Your tax plan doesn’t have to be labor intensive. In fact, there are many tax management strategies that work in the background, helping you achieve your financial goals while minimizing the impact of taxes.
With an ongoing tax reduction plan, and a partnership with an experienced financial advisor, you can keep more of your hard-earned money while making progress towards your financial goals. Consider how these tax reduction strategies could fit into your financial plan.
Contribute to Your Retirement Accounts
Making regular contributions to your retirement accounts can reduce your taxable income as well as help you prepare for your dream retirement. There are several types of tax-advantaged retirement plans, but the most common are employer sponsored 401(k)s and Individual Retirement Arrangements [IRA]s. By taking advantage of these tax-advantaged retirement accounts, you can make progress towards your financial goals and lower your tax bill simultaneously.
Contribute to Employer Sponsored Plans
Employer sponsored retirement plans like Traditional 401(k)s are a great way to save for retirement and reduce your tax bill at the same time. When you contribute to a pre-tax employer sponsored plan, the amount of your contribution is often excluded from your taxable income.
For tax year 2022, those under age 50 can contribute to up $20,500 to a 401(k) while those over age 50 can contribute up to $27,000. This contribution limit is much higher than many other tax advantaged saving vehicles.
Keep in mind that you can only deduct contributions to Traditional 401(k)s and other employer sponsored retirement plans. If you make Roth contributions, the amount you contribute will not help to reduce your current taxable income, though Roth could provide tax benefits down the road.
If you want to contribute to your employer sponsored plan, consider setting up automatic contributions and maximizing your company match, when applicable. These steps will help you stay focused on your goal and make sure you never miss a contribution.
Save More with an IRA
If you have already contributed the maximum to your employer sponsored plan, or your employer doesn’t offer retirement benefits, consider contributing to an Individual Retirement Arrangement [IRA]. You can open an IRA with your financial advisor and, if you make regular contributions, you reduce your taxable income each year.
In 2022, individuals under age 50 can contribute up to $6,000 to their IRAs while those age 50 or older are capped at $7,000. Contributions to a Traditional IRA may be tax deductible depending on your filing status, income, and employer retirement benefits. If you’re not sure that you are eligible to deduct your contributions, speak to an experienced financial advisor.
Consider Roth Contributions for Future Tax Benefits
Traditional 401(k) and Traditional IRA contributions delay your taxes and can provide an immediate deduction. Roth contributions, on the other hand, don’t provide immediate tax benefits, but could reduce your taxes in the long run.
Here’s how it works: When you contribute to a Traditional retirement plan, you receive a tax deduction for your contribution in that tax year. When you take funds from your plan during retirement, you pay taxes on the amount of your distribution which includes principal and earnings. With Roth contributions, you don’t receive a tax deduction for your contributions. However, when you take qualified distributions during retirement, you don’t pay tax on your withdrawals. This could mean that you never pay tax on the earnings in your account.
Depending on your current tax rate, your time horizon, and your tax rate during retirement, allocating a portion of your retirement funds to Roth could save you money in the long run. To determine which type of retirement account is best in your situation, speak to an experienced financial professional at Brookstone Wealth Management.
Contribute to a Health Savings Account
Health Savings Accounts [HSA]s, can provide extensive tax benefits in the current year and throughout your life. In fact, these accounts are one of the only types that are triple tax advantaged. The three tax advantages are: a tax deduction when you contribute, tax-free qualified withdrawals of principal, and tax-free qualified withdrawals of earnings.
In 2022, you can contribute up to $3,650 for an individual and $7,300 for a family but only if you have a compatible high-deductible health insurance plan. Unlike funds in a Flexible Spending Account for medical expenses, funds in an HSA don’t expire. So, you can save now, invest your funds, and then use them throughout your life to cover qualified medical expenses, all while reducing your taxable income.
If you withdraw funds from an HSA for non-medical expenses before you reach age 65, you could owe income tax and a 20% penalty. However, after age 65, you can choose to withdraw your funds for any reason without penalty. This makes an HSA an attractive option for additional retirement savings. However, it is important to keep in mind that if you use your HSA funds to pay for non-medical expenses, you could still owe income tax on your distribution, even after age 65.
Donate to Charity
When you donate cash or property to an eligible charity, you could receive a tax deduction. However, the amount you can deduct varies based on the type of charity and the type of property you donate.
There are several ways that your financial advisor can work with you to maximize your charitable deductions. For example, some investors will choose to donate appreciated stocks or other assets to charity in order to reduce their taxable income while avoiding capital gains tax on the asset.
If you plan to donate a significant amount to charity, there are more advanced charitable strategies, like Charitable Remainder Trusts and donor-advised funds, that you can employ. To learn about the ways that you can maximize your charitable deductions, contact an experienced financial professional at Brookstone Wealth Management.
Reduce Your Tax Burden with Financial Fingerprint™ by Brookstone Wealth Management
Managing taxes is an ongoing process. That’s why it’s important to work with a financial advisor that has access to experienced tax, legal, and investment professionals, like those here at Brookstone Wealth Management.
Our experienced team has developed a proprietary wealth management plan called Financial Fingerprint™ which helps you manage every aspect of your finances – including taxes. Best of all, Financial Fingerprint™ is quick to assemble, easy to understand, and simple to modify as your circumstances change.
With Financial Fingerprint™ and an experienced financial partner, you can maximize your investment returns while minimizing the impact of taxes. At Brookstone, our focus is on coaching, teaching, and mentoring our clients, and we look forward to setting you on the path to your True North. To get started, contact us today.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary.