As we begin the new year and get closer to tax day in April, many of us are thinking more about planning for taxes and different strategies we can take to be more tax-efficient. Many federal tax policies and priorities are still up in the air, which can lead to some confusion as to what to do when it comes to planning. Regardless, there are still many tried-and-true tax planning strategies for you to consider that will likely work in most environments.
Defer your income
For a majority of taxpayers, their ordinary income tax rate isn’t likely to change any time soon. This provides a good opportunity to defer your income. A tax-deferred investment is when you pay federal income taxes when you withdraw the income, rather than paying the taxes initially. The earnings you make on this investment are also tax deferred until you take the money out.
Since your money is being reinvested, you are giving it time to compound and potentially grow. This may allow your investment to be larger than a similar investment that would be subject to capital gains tax each year. Another potential benefit of deferring your income is that you may be in a lower tax bracket when you withdraw the money than when you initially invested it. Something to keep in mind is that this is more of a long-term strategy, so there are restrictions on when you can withdraw the money without penalty.
There are many different strategies you can look at here, including traditional IRAs, HSAs, 401(k)s, annuities, and more. Your tax advisor can help you decide which of these strategies makes the most sense for you.
Optimize retirement plan contributions
The maximum allowable 401(k) contribution for 2022 is $20,500, with a $6,500 additional contribution, if the plan allows, for taxpayers who are 50 and over. A lot of companies will offer a 1:1 match of funds up to a certain percentage, so you can get an extra benefit on top of what you are contributing. The contributions that you make are made with pre-tax money, so you can lower your overall tax bill for the year. Even if you aren’t able to make the maximum contribution per year, it would still be beneficial to contribute up to your company’s match amount so you aren’t missing out on any matching contribution.
Other things to consider are contributing to your HSA and contributing to an individual retirement account (IRA).
Health Savings Accounts (HSAs) are a great tool to help you invest and pay for qualified health care expenses tax free. Any unspent funds can be invested and saved for a later date, potentially growing and giving you more money to use in retirement. Not only are HSAs good for investing, but there are several potential tax benefits to them as well. The money that you invest into your HSA comes out of your paycheck as a pre-tax deduction, providing immediate savings on your income taxes. You also don’t have to pay taxes on any investment growth that you see from your HSA. Like many 401(k) retirement savings plans, your employer may offer matching contributions on your savings, so be sure to save enough to take advantage of any additional dollars that can further grow your savings.
Learn more about HSAs here.
Individual Retirement Account (IRA)
IRAs are one of the most popular tools that Americans use when saving for retirement. IRAs offer a lot of flexibility and an array of different investment options. Not only are they a popular investing tool, but they also offer some potential tax savings as well. Traditional IRAs allow you to take an upfront tax deduction when you make a contribution, but withdrawals will later be taxed at ordinary income tax rates. While there is still a risk with investing, this is just another possible way for you to be more efficient with your tax planning. Working with a financial professional can help you decide what is the right choice for you.
Learn more about traditional IRAs here.
Make sure you take your required minimum distribution (RMD)
If you are 72 years or older, you must take your required minimum distribution from your qualified plan and IRA.
Explore using a Roth IRA
Roth IRAs are another tool to help you save and invest for retirement. The contributions you make to a Roth IRA are taxed upfront when you put the money into the account. This means that when you go to take the funds out during retirement you won’t be taxed (as long as certain requirements are met). A tax-efficient retirement income plan using Roth accounts and other tax-free income sources can help ensure your savings lasts longer in retirement, so be sure to talk with a financial professional about this important savings option.
Even with the uncertainty in tax law changes, these are a few consistent tax strategies you can implement to potentially help yourself now and in the future. Nationwide has a variety of resources to help you with your investing and tax planning. Find a financial specialist to help you meet your financial goals today.
Investing involves market risk, including possible loss of principal, and there is no guarantee that investment objectives will be achieved.
This information is general in nature and is not intended to be tax, legal or other professional advice. Federal income tax laws are complex and subject to change. The information presented here is based on current interpretations of the law and is not guaranteed.
Nationwide and its representatives do not give legal or tax advice. An attorney or tax advisor should be consulted for answers to specific questions.