The key to paying less in taxes is strategically reducing your taxable income.
Tax planning may seem intimidating to many. Where to start? What if they think I’m evading taxes? It is just too complicated. Tax planning is complicated, and that is exactly why so many people end up paying more than they need to year after year. Let me just ask you one question — Do you want to pay less in taxes each year? You can. You just need to take advantage of these three simple strategies.
1 — Contribute to retirement accounts
2 — 529 Savings Plan
3 — Employer sponsored savings accounts: healthcare savings accounts and childcare savings accounts
Contribute to retirement accounts
Whether it is a 401K or IRA, contributing to your retirement account can reduce your taxable income. While there are limitations, this is an easy way to reduce your taxable income and grow your wealth.
For 2020 there is a $6,000 limit on taxable contributions to retirement accounts. But, if you are over 50, you can contribute another $1,000.
With that being said, you can open an IRA for each spouse, doubling the tax deduction. That is a total of $12,000 you can defer paying income tax on.
It is important to understand the differences in the types of IRAs before you consider contributions. I won’t delve into that here, but it is important to understand contributions to a traditional IRA are tax-deductible, contributions to a Roth IRA are not.
401K contributions is another retirement plan to consider. The more you add to these accounts, the more you can reduce your taxable income, effectively helping you build wealth for the future.
Keep in mind, some employees may contribute to both a 401K and IRA in the same year and defer taxable income on both, but those who earn more than $65,000 (104,000 for couples) are unable to take the deduction for both.
529 Savings Plan
College is expensive. Shoot, primary education is expensive if you elect to send your children to private institutions. Either way, shucking out a huge chunk of dough for tuition is frightening and stressful, but it doesn’t have to be. 529 Savings Plans can ease that stressor as well as offer some relief during tax time.
Before I jump in you should know, you cannot get federal tax deductions on contributions to your 529 plan. But, you may be able to obtain state tax deductions, and earnings are not considered taxable income. One other noteworthy mention — you are able to shop outside your state, which may allow for a better rate of return.
$5,000 (10,000 if married) is deductible if you utilize this tax planning strategy.
In order to obtain the greatest benefit, it is important to start early. So, if you have young kids, go ahead and get their plan opened and begin contributions.
An important tax implication to consider is that contributions to a 529 Savings Plan are considered a present interest taxable gift to a beneficiary. With that being said, you may apply the annual gift exclusion of $14,000 per person a year.
Employer-Sponsored Savings Accounts
Next time your employer’s benefits enrollment period rolls around make sure to pay close attention to the employer-sponsored savings accounts. Many employers now offer employer-sponsored savings accounts for things such as childcare and healthcare.
The wonderful thing about these accounts is that you can contribute to them on a pre-tax or tax-deductible basis. Your savings can grow free of taxes over time and you can make tax-free withdrawals to cover childcare costs and qualified medical expenses.
In 2020, you can contribute $3,550 in your single coverage high deductible health savings plan. For family plans, you can contribute up to $7,100.
Warren Buffet once famously said that he pays a lower tax rate than his secretary. How is that possible? It is possible because there are a plethora of ways to lower your tax rate, but tax planning requires strategy. Tax planning requires more than just an accountant. It requires more than just entering the figures into a tax tool. It requires hard work and knowledge.
Tax planning knowledge is essential on your journey to build wealth, so start with these simple ways to reduce your taxable income and continue to grow.