Tax Planning. It sounds complicated right?
Well, it can be, but there are four basic things you should probably be doing.
1. Maximize Retirement Contributions
Are you maxing out your 401(k)? I don’t just mean contributing enough to get your company match; I mean MAXING it to the percentage allowed by your company or the $17,500 (or $23,000 if you are over 50) allowed by the IRS (2012 limit)? Contributions reduce your taxable income, which of course reduces your tax.
How much could it save you? With an effective 25% tax rate, a $17,000 contribution would reduce your tax bill by $4250 for the year of the contribution. While the money is in the account, earnings are tax-deferred. These are significant benefits.
If you don’t have a 401(k), SEP IRA, SIMPLE IRA or other retirement plan, you can contribute to a Traditional IRA.
If you are a business owner and you have not set up a retirement plan for your business, what are you waiting for? This may be the most effective tax reduction strategy available to you.
2. Fund other Tax-Sheltered Accounts, if Appropriate.
529 College Savings accounts grow tax free, and withdrawals for qualified educational expenses are also free of tax. Some states (including NY) have additional state tax benefits for contributions as well.
Health Savings Accounts (HSA) are another. Contributions are made pretax, and withdrawals for qualified medical expenses are free of tax. (Health Savings Accounts are available in concert with a High Deductible Health Plan).
Dependent Care Savings Accounts (DCSA) and Flexible Spending Accounts (FSA) allow you to use pre-tax money to pay for child care and medical expenses. Generally speaking, paying with pre-tax money means your effective tax rate percentage (say 25%) is the additional amount of funds available.
Please note that non-qualified withdrawals from these accounts may be subject to taxes and penalties. Please read the summary plan description for these accounts before making any investment decision.
3. Review Capital Gains Before the End of the Year, Every Year.
Think back. Do you have any large financial transactions this year? Did you sell property, sell an investment or receive company stock? These are all things which may have tax implications. Wouldn’t you rather know before the end of the year (when you can potentially offset them), than at tax time, when a large bill is due?
4. Save Your Receipts
If you itemize your taxes, please save your receipts. Charitable contributions can really add up throughout the year. If you are a business owner, freelancer or independent contractor, business expenses will reduce your net income from your business, which you guessed it, reduces your tax.
Sure, there are other tax strategies which may be appropriate, especially for higher incomes and business owners. But these are an easy place to start. Are you tax planning?
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material, is not a complete summary or statement of all available data necessary for making an investment decision, and does not constitute a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Be sure to contact a qualified professional regarding your particular situation before making any investment or withdrawal decision.
photo credit: JD Hancock via photopin cc
She lives in Montauk, NY with her husband, 3 kids and Labrador puppy.
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