Many people do not love doing their taxes but digging a little deeper into how the system works can benefit you in several ways. You may be unnecessarily paying taxes on money that can be tax-free, or you may be interested in learning how to create a better future yourself with some available options that are tax deferred. In any case, it is incredibly beneficial to look into more ways to save money for both the long and short term. Since there are many different strategies for planning on how to do your taxes, consider a few of these popular options that might be a good fit for your situation.
Lower Your Taxable Income to Save on Taxes Right Now
One of the most innovative ways that can lower your taxable income and pay less to Uncle Sam each year is to create a traditional IRA or contribute as much as possible to your 401(k) account. All the money you invest in either of these types of accounts is tax-deferred, meaning you do not need to pay any taxes on them until you withdraw the money several years down the road. Not only will you be saving for the future, but you will be sending the government less of cash now.
Convert Your IRAs and 401(k) Accounts
Most people know that creating a traditional IRA and contributing to a 401(k) means you may able to reduce taxes for now, but you will be taxed when you decide to withdraw the money. However, Roth IRAs are taxed before going into the account, so you can withdraw from those accounts without being taxed in the future. During years when tax rates are lower, it may be wise to convert your traditional IRAs to Roth IRAs and take advantage of the savings that way. If you have a hefty 401(k) or traditional IRA and cannot afford to pay taxes on the conversion upfront, you can make a partial move this year and pay the rest next year.
Maximize Health Savings Accounts
Even if your employer offers you an HSA (Health Savings Account), you can open your own through a bank or another financial institution. HSAs are great if you know that you will have medical expenses during the year and your health insurance has very high deductibles. These accounts can be tax-free and tax-deductible if used for qualified medical expenses, so families or individuals with expensive health issues can significantly benefit from a plan like this. While you are still spending your own money, you can at least get a break from the tax portion of those costs.
Set Up and Use Dependent Care Flexible Spending Accounts
This tax-saving strategy is great for parents or anyone who has a dependent living in their house. Have your employer divert up to $10,500 of your yearly salary to a Dependent Care FSA, which can be used tax-free to cover expenses like daycare, preschool or after-school programs. Not only are you exempt from getting taxed on that money, but it also lowers your total taxable income for the year.
While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.
Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
HSAs are never taxed at a federal income tax level when used appropriately for qualified medical expenses. Also, most states recognize HSA funds as tax-free with very few exceptions. Please consult a tax advisor regarding your state’s specific rules.