By: Colleen Weber
News and Updates / Tax Planning
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By Colleen Weber, CFP®, CPA
I’ll let you in on a secret: one of the best ways to retain more of your wealth is to reduce the burden of taxation. And this isn’t something to deal with once a year when tax day comes; ongoing tax planning can help you strategically reduce your tax bill so the IRS doesn’t get more of your money than they should.
Think of taxes like a game—if you understand the rules, you will have a much higher success rate. Here are some ideas to help you “win the game” of reducing your tax bill by taking advantage of the benefits available to taxpayers.
Create a Tax-Efficient Retirement Plan
When working with your advisor to create your financial plan, retirement planning will often be a key point of conversation. By stress-testing your plan, you can quickly see if your current retirement accounts, savings rates, and other assets will provide for your ideal retirement lifestyle.
A direct way to reduce your tax bill is to contribute money into tax-deferred savings accounts, such as a 401(k) or IRA. But in order to maximize your savings, you will need to determine both your current cash flow needs and your ideal retirement income. A financial plan will look at both factors and determine the best way to use your tax-deferred savings accounts to save you money both now and in the future. For example, a $50,000 withdrawal from a Roth IRA will have a wildly different tax impact than that same distribution from a traditional IRA. Creating a tax plan can help you strategically withdraw from your various retirement accounts and reduce your tax liability.
Contribute to a Health Savings Account
As a refresher, health savings accounts (HSAs) offer a triple-tax savings. It may sound too good to be true, but HSAs have no federal income tax, no state or local taxes, and no Federal Insurance Contribution Act (FICA) taxes. If you are eligible for an HSA, your money will be tax-deferred and can be withdrawn tax-free to pay for medical expenses.
Because HSA account balances simply roll over from year to year, by contributing to the limit each year, you can build up quite a nest egg to cover either current medical expenses or future medical expenses in retirement. Think of it as a Roth IRA for medical expenses. For 2022, HSA owners now have higher contribution limits to help them do just that. If you have individual coverage, you can contribute $3,650, and for family coverage, your limit is $7,300, with an extra catch-up contribution of $1,000 available for those over age 55. (1) If you can’t max out the yearly limit, attempt to contribute enough to cover your deductible and take advantage of your employer match, if available.
Use a Roth IRA to Transfer Wealth
Roth IRAs are an attractive savings vehicle for many reasons, including no required minimum distributions (RMDs), tax-free withdrawals after age 59½, and the ability to pass wealth tax-free to your heirs.
You probably know the effects taxation can have on your assets and the inheritance you hope to pass on to future generations. For example, if you passed down a traditional IRA, non-spouse beneficiaries used to be able to stretch out the distributions from that account over the beneficiary’s life, but now they have to liquidate the account within 10 years of inheriting it (with some exceptions), thanks to the new SECURE Act. This significantly decreases the value of the account due to the amount of taxes paid in a short time.
But if you pass down a Roth IRA instead, there is no income tax due on the distributions as long as the account is held for more than five years and the account holder is 59½ or older.
If you have traditional IRAs already or earn too much to qualify for a Roth IRA, consider a Roth conversion to remedy the tax loss. The basic process to convert your IRA is to withdraw the amount you’d like to invest in a Roth, pay the tax owed on the distribution, then reinvest it into a Roth account. Be sure to work with a professional to determine the best time to do this so you don’t push yourself into a higher tax bracket or find yourself forced to use funds from the account to pay the extra taxes on the distribution. Also, stay on top of potential tax changes that could limit the availability of this option for you. (2)
Deduct Eligible Charitable Contributions
Annual gifts to qualified charitable organizations may be deemed an eligible itemized deduction. Under the Tax Cuts and Jobs Act, fewer taxpayers itemize deductions due to the doubling of the standard deduction. (3) Regardless, charitable giving is still a useful tax-minimization strategy.
In order to benefit from charitable giving, you’ll have to plan ahead. With the new higher standard deduction, you’ll need to make sure your total deductions for the year, giving included, exceed $12,550 for an individual filer, and $25,100 for married filing jointly. (4) If your deductions fall below this amount, consider bunching your giving or doing several years’ worth of giving in one year.
You may also want to look into using a donor-advised fund to combine all charitable contributions in a year and then distribute the funds to various charities over several years. With this strategy, you may be able to itemize deductions in one year and take the standard deduction in the following years so you can achieve a tax benefit that you may not have received otherwise.
Review Your Previous Tax Returns
You can learn a lot from the past. Look at your previous tax returns with a professional to search for deductions or credits you may have missed, opportunities to lower taxable income, and plan for the next tax season. Take these factors into consideration when making a tax plan for the future:
- Review notable tax law changes for 2021 that may affect you.
- Review your capital gains and losses.
- Review your retirement savings options.
- Consider Roth IRA conversions.
- Consider additional year-end tax strategies.
- Understand potential tax law proposals.
Getting Ahead With Tax Planning
While tax planning could potentially save you money, both today and in the future, taxes can be complicated—it’s estimated that it would take you eight weeks of nonstop reading to get through the lengthy and complicated IRS tax code, which is filled with various opportunities and strategies for optimal tax efficiency. The key is partnering with an experienced professional who can help you understand how each possible opportunity works and how it fits into your strategy and long-term goals.
With years of experience in financial and tax planning, I know how to implement appropriate tax-minimization strategies to help you save more of your hard-earned money. If you have questions about any of these tax strategies and whether they’d be right for you, we encourage you to reach out to us. Book a free introductory meeting online!
Colleen Weber is a fee-only financial advisor, CERTIFIED FINANCIAL PLANNER™ professional, and CPA with more than 15 years of financial planning experience. Providing comprehensive financial planning and wealth management, she specializes in serving clients nearing retirement, retirees, busy professionals, and women. She is passionate about developing financial plans that save clients on taxes and investment strategies that help them pursue their goals. Learn more about Colleen by connecting with her on LinkedIn or booking a complimentary phone call meeting.