It’s tax time again and if it brings on feelings of anxiety and dread, we’re here to show you how filing your income taxes can be less … well, taxing. It’s easy to feel swamped by the prospect of gathering information, or if you’ve already submitted your documents and find out you may owe additional taxes, you’re not alone.
Looking across your spending over the last year, you may see the taxes you paid — whether income, payroll, property or sales — consumed a large portion. You get anxious. Or, you had a better earning year than expected or you sold an investment, a business or received a large payout from another source. Good or bad — it all affects your income and can complicate the filing process.
We get it.
So, what can you do NOW to minimize your taxes going forward?
Tax payment fatigue is real, but with a little planning, you can reach your long-term goals without getting strung out by the process.
1. Fully fund the retirement accounts offered to you by your company or by using the retirement savings tools available to you if you are self-employed.
401(k) Plans, 403(b) Plans and IRAs may all work toward deferring taxes and creating wealth for you. If you own a company or operate as a solo practice, SEP IRAs, SOLO 401(k)s, Defined Benefit Plans, and SIMPLE IRAs all allow you to save much of your income.
2. Take full advantage of unparalleled tax savings by using Health Savings Accounts (HSAs) as retirement investment vehicles.
Health savings accounts, or HSAs, can be utilized as spending vehicles to pay for current medical expenses if you have a high-deductible health care plan. However, savvy account holders are increasingly using them as retirement investment vehicles.
HSA contributions are either pretax, if done through payroll withholding, or tax-deductible, if contributed after-tax. And you don’t have to itemize to get the tax deduction! That means you always get a tax break when paying for qualified medical expenses with an HSA, regardless of what deduction you choose or if your healthcare costs exceed the AGI threshold.
If you choose the standard deduction on your tax return, but also want tax breaks for your medical expenses, an HSA enables you to get both. And in addition to not being taxed upon contribution, HSA funds are tax-free as they grow, as well as when they’re withdrawn to pay for or reimburse qualified medical expenses. If saving on taxes matters to you, an HSA is the undisputed best way to pay for your healthcare costs.
3. Asset Location, Location, Location.
The first decision you make with respect to your portfolio is its asset allocation, or the mix of stocks and bonds. Asset location refers to where you hold various types of assets across your taxable, tax-deferred and Roth accounts.
Why does asset location matter?
It matters because different types of investments are taxed at different rates and at different times.
For example, interest on bonds is taxed as ordinary income when an interest payment is made (typically twice per year).
Stocks have components to their return: dividends and capital gains. Dividends (if they are qualified) are taxed at favorable rates when they are paid. The capital gains tax rate is lower than the tax rate on ordinary income, especially for high-earners, and taxes on capital gains aren’t paid until the asset is sold.
There are also other benefits to holding stocks in a taxable account.
If you hold stocks in a taxable account until your death, you’ll get a step-up in cost basis, which eliminates capital gain taxes for you and your heirs. This effectively makes the capital gains portion of the return tax-free if you held the stocks for a long time.
If you are feeling charitable, you can donate appreciated shares and pay no tax on capital gains.
Holding stocks or mutual funds of stocks in a taxable account also gives you the option to harvest losses. Tax-loss harvesting allows you to utilize losses to offset current or future capital gains, or potentially offset $3,000 of ordinary income on an annual basis.
4. Utilize ROTH conversions of tax-deferred assets to reduce the taxes you’ll pay over the long run.
High-earners can’t invest directly into Roth IRAs due to income limitations (maximum $139,000/yr for the tax year 2020 if filing solo, and $206,000 if filing jointly), but you can transfer assets from a traditional to a Roth IRA in years when your income is lower.
Going this route could lower your income taxes over your lifetime. The amount converted is subject to ordinary income tax but provides future income tax-free growth potential. Roth IRA planning during working years can also entail Back-door Roth IRA conversion and Mega back-door Roth conversions.
Make smart decisions on income in the years before you file for Medicare.
When you’re able to enroll in Medicare, Part B and D premiums are dependent on the income reported on your tax return from two years prior. Managing your gross income by reducing capital gains or minimizing distributions from your retirement accounts can help reduce your premiums.
You may need the assistance of a financial advisor or CPA to ensure you’re making the right decisions for ROTH conversions, and all other tax savings strategies. Each plan is different and it’s critical you find what works best for you during the years leading up to and into full retirement.
5.Utilize your required minimum distribution (RMD) from your retirement accounts for a cause you support.
If you’re at least 70½ you can potentially reduce your income tax burden while also meeting your charitable intent.
Using a Qualified Charitable Distribution (QCD) can fully or partially fulfill your Required Minimum Distribution (RMD) and reduce your taxable income for the year in which you make the QCD. You have the ability to make a QCD of up to $100,000 per year directly from your IRAs to an eligible organization.
What qualifies as an eligible organization? Pretty much any nonprofit organization that qualifies for tax-exempt status according to the U.S. Treasury. That means it must have 501(c)(3) status and not go directly to any private shareholders or individuals. Anything that influences legislation in any way is also out the window.
Keep in mind, for an IRA distribution to qualify as a QCD, it must satisfy certain requirements (e.g., must be paid directly from your IRA to an eligible organization).
Make sure to work with a tax advisor to ensure you satisfy all the QCD requirements and that QCDs and RMDs are correctly reported on your tax return.
WHERE DOES CSW FIT IN?
For the past 10 years, Cogent Strategic Wealth has helped busy, thriving professionals make sense of their financial plans and manage the many complex items that go into effective tax planning.
Tax laws evolve, as does your situation. Staying up-to-date can be arduous, time consuming, and unnecessarily stressful especially when your goals revolve around spending time with family and enjoying the wealth you’ve worked hard to build.
Planning appropriately for your goals and mitigating taxes can be accomplished simultaneously. We’ve barely scratched the surface of the actions you can take to maximize your tax savings and build your wealth. That’s the benefit of hiring a fiduciary advisor. Having someone in your corner with your best interests in mind can be the best financial decision you ever make.
At Cogent Strategic Wealth we work with families like yours every day to convert dreams into plans, and plans into reality. Contact us today so we can help you, too. Your money and your dreams hang in the balance, so let’s get to work!
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