Forward-Thinking Tax Strategies for Next Year’s Filing Season

Tax season can be a stressful time. Getting organized, finding a trusted CPA or going the DIY route, and determining whether you’re getting a refund or need to make a payment are all overwhelming parts of the tax season process. The worst part? It can be hard to know whether you’re getting a refund or that you’ll owe money to the IRS because you’ve underpaid.

Having the wrong tax strategy can have a pretty serious impact on your overall financial health. Not only will you be left holding the bag when you realize you owe money after you file, but you might be overpaying every year because you’ve not taken advantage of tax saving strategies.

Your best bet? Take the lessons you’ve learned this year and start thinking ahead. If you start now, you’ll be able to use the motivation you have during filing season to keep yourself financially healthy year round (and possibly even pay less in taxes next year).

No Strategy Cancels Out Taxes

Before we dive into some forward-thinking tax strategies, I want to clear something up: you’re not going to fully cancel out your taxes – no matter what. If you’re looking for a quick-fix to tax payments, you won’t find one. Or the ones you do find are likely scams. Get comfortable with the idea of paying taxes, and work to understand how they impact your finances. A goal of owing a small amount each year in Federal and State taxes makes sense – usually no more than $1,000. The trick is finding a way to be efficient in how and when you pay taxes, both now and in the future.

Check Your Withholdings

Many people wrongly assume that they can only update their W-4 to reflect accurate federal tax withholdings once a year – like you would with your health insurance and employee benefits open enrollment period. You can actually adjust your federal tax withholdings any time.
As your lifestyle changes with time, the information on your W-4 should be changing, as well. If you don’t claim your spouse or kids on your W-4 as exemptions, you should absolutely look at adjusting them in the near future. Withholding too much or too little can hurt you come tax time!

Don’t Withhold Too Much

It’s tempting to avoid the stress of tax season by overpaying throughout the year. While this helps ensure you won’t owe taxes after you file, it definitely doesn’t help your finances.

There’s a cultural hype around getting a big tax return. Advertisers start pushing you to spend the refund before it even comes your way! But honestly, having a big tax return isn’t something to be proud about. All it means is that you gave the federal government an interest-free loan all year, and now you’re getting it back. The money was yours to begin with, and you just spent a year without it. You’ve effectively given the government an interest-free loan – which doesn’t help your financial situation.

It’s way more beneficial to dial in your tax withholdings early on to make sure you’re not getting a refund. Admittedly, this is difficult because it’s a fine line between owing money when you file and not getting anything back.

Feel free to err on the side of caution, but don’t withhold too much, either. Those funds can be used throughout the year to free up cash flow that could be going toward your debt repayment or other savings goals. Typically, I recommend that clients should have a goal of paying in $1,000 each year.

Utilize Accounts with Tax Benefits

Once you get your withholdings figured out, you can start working tax-efficient strategies into your tax plan. Although these definitely won’t eliminate taxes completely, they can potentially lower your total taxable income – which means they’ll lower the taxes you pay, as well.

Your Workplace Retirement Plan

Many workplace retirement plans allow for Roth (after-tax) and pre-tax contributions. After-tax contributions don’t reduce your current taxable income but do boost your retirement savings in the long-term. Pre-tax contributions are made with funds withheld from your paychecks that are not taxed in the current year. These contributions do help to lower your taxable income.
This means a portion of your paycheck is deposited into your retirement plan before the federal government takes taxes out of your salary. You’ll be lowering your current taxable income while saving for the long-term goal of living a comfortable retirement.
Generally speaking, once you reach age 70 ½, your pre-tax accounts will be subject to Required Minimum Distributions (RMDs). This is how the IRS gets “their share” of all the pre-tax money you’ve been contributing to your retirement account over the years. However, with a qualified financial planner, you can strategically plan for minimizing the impact that these RMDs have on your retirement income.

Health Savings and Flexible Spending Accounts

If you have access to an HSA or FSA through your employer, you have another way of lowering your taxable income. These accounts, typically associated with a High Deductible Health Plan, are also funded using pre-tax money from your paycheck. They can be used to cover qualifying medical expenses tax-free. You might use them for copays, flu medicine, or hospital bills.

529 Plans

529 plans are used to save for education expenses – typically for your children or grandchildren. Although they don’t lower your taxable income, they do have tax-free interest. Additionally, all qualifying withdrawals are free.
However, 529 plans should be a last resort if you have debt you’re paying down or other savings goals. There is never a reason to sacrifice your own retirement and financial wellbeing to set funds aside for your kids’ college education.

Roth IRAs

Although Roth IRAs don’t reduce your taxable income in the current year, they’re still an awesome (and tax-efficient) planning tool. A Roth IRA allows you to put after-tax contributions in now, they grow tax-deferred, and any qualified distributions (i.e. after 59 1/12) are tax-free. This means that qualified distributions are tax-free. You can also withdraw contributions at any point for any reason – making them a useful savings tool.

Want Help? Talk to a Pro

When it comes to financial professionals, you have your pick of a financial advisor or Certified Public Accountant (CPA). Your financial planner and CPA will work together to ensure you are being as tax-efficient as possible. If you want to talk about how to build tax-efficient options into your finances, feel free to contact me today. I’d love to help!