When the leaves turn, holiday planning kicks into overdrive. We are heading into the busy season full of budgets, presents, and navigating family visits. One thing you don’t need to add to your to-do list is managing taxes. Before the holiday frenzy sets in, take some time to implement tax-efficient strategies to help minimize your tax bill next spring. Let’s explore 6 fundamental ways to lower your taxes before year-end.
1. Dust Off Your W-4
Did you owe a lot of money on your tax return last year? Or were you surprised by a significant refund check? Either one of these scenarios means you need to update your withholdings on your W-4.
A W-4 is a form issued by your employer to determine your tax withholdings from each paycheck. You can revise your W-4 at any time, and it should be updated after a major life event like marriage, children, divorce, a big salary bump, or a significant asset gain.
Since your W-4 is linked to your taxes, the information must be accurate to ensure you’re withholding the right amount of taxes each pay cycle. If your tax bill was a bit out of whack last year, here are a few things you can do:
- If you were surprised by a significant tax bill, raise your withholdings to satisfy your tax requirements.
- If you received a big refund check, lower your withholdings. There is no sense in giving the IRS more paycheck than you need to. That extra money can (and should) be reinvested into your retirement funds, brokerage accounts, emergency fund, or other saving ventures.
Checking-in on your withholdings is an underrated way to bring balance to your taxes.
2. Max Out Your Retirement Contributions
Saving for retirement is not just prudent for your future self, it can also save your current self a lot of money on your tax bill. Most retirement accounts are tax-advantaged, meaning they offer tax benefits for contributing. Let’s walk through a few accounts you shouldn’t forget about this year.
First, look at your Traditional 401k. While you likely contribute regularly through payroll deductions, how much have you saved this year? In 2020, you can deposit up to $19,500, with an extra $6,500 for those over 50. Since contributions are tax-deductible, when you contribute, you lower your taxable income for the year. Removing nearly $20,000 from your earned income can go a long way in regulating your tax bill.
You should also check your IRAs. A traditional IRA operates just like your 401k, so all contributions are made with pre-tax dollars and lower your taxable income. The maximum contribution limit is $6,000, with an extra $1,000 available for catch-up contributions. Keep in mind that if you contribute to both a 401(k) and an IRA, your ability to deduct contributions to your IRA may be impacted.
Have a Roth IRA? Contribute to that as well. Even though contributions aren’t tax-deductible, tax-free withdrawals can be a significant asset in retirement. Remember, Roth IRAs carry income thresholds, meaning if you make over a certain amount you can’t directly contribute ($139,000 for single filers and $206,000 married filing jointly).
Since 2020 has been a lower-income year for many, you could also consider a Roth Conversion before year-end. A Roth Conversion allows you to rollover funds from your Traditional IRA into a Roth IRA. While you must pay taxes on the transfer, if you’re in a lower tax bracket now it could save you a substantial amount of money in the long-run.
Health Savings Account (HSA)
Are you enrolled in a high-deductible health plan? If so, consider making additional contributions to a health savings account (HSA). This is a tax-advantaged account designed to bolster savings for medical expenses.
All contributions are pre-tax, which once again lowers your taxable income, making investing in this account a great year-end move. You can put in $3,550 for self-only coverage or $7,100 for family coverage. There is also a catch-up contribution of $1,000 for those over 55.
One benefit of the HSA is funds roll over year to year, making it an excellent long-term investment vehicle. Certain employers will even match some of your HSA contributions.
3. Defer Extra Income
Another strategy to consider is deferring 2020 income to 2021. While you might be unable to defer your regular paycheck, you could delay a year-end bonus to the start of 2021. For example, if you’re self-employed and report income on a cash basis, you can bill toward the end of December so the payment posts at the beginning of the year.
This strategy only works if you expect to be in the same (or lower) tax bracket the following year. Should your tax bracket increase, deferring income would only exacerbate things and could have the inverse effect of increasing your tax bill.
4. Plan Your Deductions
In the quest for tax-efficiency, you need to answer this question: Will you itemize or take the standard deduction?
With the standard deduction at $12,400 for single filers and $24,800 for married and filing jointly, many families must be strategic when itemizing deductions. A savvy way to take advantage of itemizing is through bunching or batching deductions. Bunching means you can itemize one year and take the standard deduction the next.
For example, you can group charitable contributions, your state income tax bill, property tax, and other deductible expenses to capitalize on itemizing, which could save you a lot of tax money.
You can also batch your charitable contributions. Let’s say you usually give $15,000 per year to charitable organizations. Since that number wouldn’t allow you to itemize, you could give $30,000 every other year. This way, you still give the same amount to your favorite organizations while also taking advantage of the tax benefits.
This year, a CARES Act stipulation can also help families with their charitable efforts. One provision states anyone can make a $300 above-the-line contribution to charity. This means anyone can deduct up to $300 for charitable contributions, even if they opt for the standard deduction. While a modest limit, it could be a great way to donate to a cause you care about, especially during the pandemic.
5. Don’t Forget About Your FSA
A flexible spending account (FSA) operates like an HSA. Contributions are made pre-tax, grow tax-free, and distributions remain tax-free for qualified medical expenses. You can contribute up to $2,750 in 2020.
But funds in your FSA expire each year. Unlike an HSA where funds roll over year to year, if you don’t use the money in your FSA annually, you lose it.
You’ll want to take advantage of all the money you’ve saved through the year, so now is the time to upgrade your prescription, get new contacts, or schedule any outstanding appointments.
6. Sell Investments that Aren’t Serving You
Do any investments in your portfolio weigh you down? If so, now might be the time to sell them and harvest your losses. Tax-loss harvesting lets you offset taxes on gains by realizing a loss. You can implement this strategy up to $3,000.
But tax avoidance shouldn’t be the reason to sell a security. If you sell a stock, buy it back within 30 days, and still attempt to claim it as a capital loss, the IRS considers that a wash-sale and won’t allow the deduction.
Work with your financial advisor to intentionally rebalance your portfolio in a way that optimizes your tax situation, while retaining the right risk and market exposure for your needs.
Meet With Your Financial Team
Collaborate with your advisor and tax professionals to make a unique plan that works for you. You might be surprised by different strategies, deductions, and credits that could save money on your tax bill.
Working with a dedicated financial team can help you implement proactive tax strategies throughout the year to consistently lower your tax bill and further your financial efforts. By making smart tax choices in all of your financial decisions, it will make the end-of-year tax craze much more manageable.
Ready to take your tax strategy to the next level and expand what’s possible with money? Set up a time to talk with an advisor today.