5 Ways to Reduce your Taxes Before Year-End
What sounds more appealing: waiting in line on Black Friday to save $100 on a TV or making a few minor adjustments to potentially save thousands on your tax bill this year? Though the end of the year quickly approaches, it’s not too late to save money on your taxes in 2019. You could reduce your tax bill by contributing to retirement accounts, harvesting losses in your investment portfolio, funding a health savings account, bundling tax-deductible expenses in specific years or a combination of all of these!
1. Contribute to your Retirement Plan
We all know that saving for retirement is essential to eventually living on your own terms, but it’s easy to forget the positive impact that ongoing retirement savings can have on your tax bill today. Saving into an employer-sponsored retirement plan can reduce your taxable income each year. These retirement accounts commonly include traditional 401(k), 403(b), 457, SIMPLE and SEP plans. Because these accounts grow tax-deferred, money you save into them is deductible during the year your contribution is made. In other words, every dollar you save into your retirement plan through work, up to a maximum amount, can reduce your taxable income by that same amount. Below are a few examples based on different contribution rates:
Example 1: Save $2,400 in taxes by contributing $10,000 into your plan
Assume your gross taxable income is $100,000, and you contribute $10,000 into your 401(k) plan this year. This would reduce your taxable income to $90,000. As a single filer, you are taxed at a rate of 24% at this income level, so by saving $10,000 into your 401(k) plan, you are effectively saving $2,400 on your tax bill for this year (24% of $10,000).
Example 2: Save $4,560 in taxes by maxing out your plan
Assume you make $100,000 in gross income, and you decide to max out your 401(k) plan by saving $19,000 this year (if you are under 50 years old). As a result, your taxable income would be reduced to $81,000. As a single filer, you are taxed at a rate of 24% at this income level, so maxing out your 401(k) plan would save you $4,560 in taxes this year (24% of $19,000). If you are over the age of 50, you can make a “catch-up” contribution of an extra $6,000 for 2019.
Keep in mind that you need to contribute into your tax-deferred or “Traditional” 401(k) in these examples in order to take advantage of these tax savings. By comparison, saving into an after-tax or “Roth” 401(k) would not result in a tax deduction during the year you make your contribution. Depending on your situation, it may be in your best interest to contribute to an after-tax plan instead. Though not tax deductible, your employer may also make matching contributions into your plan which is another reason to consider saving into yours. Read more about Saving for Retirement.
2. Fund your IRA
Like with your employer-sponsored retirement plan, contributing into your Traditional IRA can also lower your tax bill. The maximum annual contribution allowable in an IRA is $6,000 in 2019 and 2020 with an additional $1,000 catch-up contribution allowed for those over the age of 50. If you or your spouse do not have a retirement plan at work, you can deduct your full Traditional IRA contribution regardless of your income. If you and/or your spouse have access to a retirement plan through work, your income may restrict your ability to deduct IRA contributions. Keep in mind, you can make 2019 IRA contributions anytime before you file your 2019 taxes (due April 15, 2020).
Example: Save $1,440 in taxes by maxing out your ira
Continuing with a hypothetical income of $100,000, maxing out your IRA contribution this year at $6,000 (if you are under the age of 50) would lower your taxable income to $94,000, assuming you do not have a retirement plan through work. As a single filer, you would be taxed at a rate of 24% at this income level. As a result of your IRA contribution, you could save $1,440 in taxes this year (24% of $6,000).
3. Tax Loss Harvest Your Portfolio
Being strategic with managing your taxable investment portfolio each year can save you a significant amount in taxes. Tax loss harvesting refers to offsetting investments at a gain with investments at a loss to eliminate or reduce your tax exposure. If you own a truly diversified portfolio, you will likely have some investments at a gain and some investments at a loss at any given point in time (hopefully more at a gain). By offsetting gains and losses, you can reduce your overall tax bill each year. Check out The Power of Tax Loss Harvesting article to learn more.
Example: Save $3,000 in taxes
Let’s assume you own a diversified portfolio in a taxable investment account with a balance of $250,000. If you tax loss harvest just 5% of the account, meaning you offset $12,500 in capital gains with $12,500 in capital losses, you could save $3,000 in taxes this year alone (24% of $12,500). This is assuming, hypothetically, that you earn $100,000 in income, and you are taxed at a marginal rate of 24% as a single filer.
4. Contribute to a Health Savings Account
You may be eligible to open and fund a Health Savings Account (HSA) if you are currently enrolled in a high deductible health plan. These accounts provide a triple-tax benefit by allowing you to make tax-deferred contributions, grow your account tax-free and make tax-free withdrawals for qualified medical expenses. In 2019, the maximum allowable contribution into an HSA is $3,500 for singles and $7,000 for families. If you are over the age of 55, you can also make an additional $1,000 “catch-up” contribution. Many people view these accounts as a supplement to their retirement savings, as it is likely health-related expenses will come up in retirement, and using HSA money to cover these is a no-brainer.
Example: Save $1,540 in taxes by maxing out your HSA
If you make the maximum annual contribution for a family of $7,000 for 2019, you can save $1,540 in taxes this year, alone (22% of $7,000). This is assuming you earn $100,000 married filing jointly with a 22% marginal tax rate.
5. Bundle Deductible Expenses
Many expenses can only be deducted if you itemize your tax deductions as opposed to taking the standard deduction. These expenses include charitable donations, medical expenses, and mortgage interest. Because the standard deduction for 2019 is relatively high compared with previous years ($12,200 for singles and $24,400 for married filing jointly), consider bundling your deductible expenses every few years instead of making them every year in order to make itemizing more beneficial and to take advantage of these deductible expenses.
For example, if you are single and typically donate $7,000 per year to various charities, consider donating $14,000 every other year as an alternative, as your donations alone would exceed the standard deduction. This would allow you to take advantage of itemizing your charitable contributions, among other expenses, to reduce your taxable income. Assuming you itemize your deductions this year (as opposed to taking the standard deduction), you can lower your taxable income by gifting cash, investments, or other property. You need to donate to a qualified charity and make sure you hold on to any receipts and other documentation so you have records of the donation.
No one likes paying taxes, and reducing your tax bill each year is much more manageable than many people think. By taking advantage a combination of these strategies, you could easily save over $10,000 in taxes in a single year. Learn more about how the examples above would apply to your unique situation by confirming your federal income tax rate and retirement plan contribution limits. It’s important to consider these options in the context of your long-term financial plan, as they may not all be in your best interest to pursue in a given year.
Do you want to talk more about reducing your tax bill for this year? Reach out to me at Ben@coveplanning.com or schedule a free consultation call.
Sign up for Cove’s Build Your Wealth Newsletter to stay informed with the latest personal finance insights!
Ben Smith is a fee-only financial advisor and CERTIFIED FINANCIAL PLANNER™ (CFP®) Professional with offices in Milwaukee, WI, Evanston, IL and Minneapolis, MN, serving clients virtually across the country. Cove Financial Planning provides comprehensive financial planning and investment management services to individuals and families, regardless of location, with a focus on Socially Responsible Investing (SRI).
Ben acts as a fiduciary for his clients. He does not sell financial products or take commissions. Simply put, he sits on your side of the table and always works in your best interest. Learn more how we can help you Do Well While Doing Good!
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Ben Smith, and all rights are reserved. Read the full Disclaimer.