Tax planning is something that you should be thinking about over the course of the year and not something you think about on April 17 when it is time to prepare your taxes. Most likely, it will be too late to benefit from any significant tax breaks if you wait until the last minute.
In this post, I am going to discuss why it is important to think about tax planning throughout the year. Next, I will provide ideas to help you get started. Finally, over the next few weeks, I will go into more detail on some more sophisticated tax planning ideas.
Let’s jump right into a simple example that will show how you can save significantly on taxes. I will be referencing my post on how to read tax brackets because this post discusses the math behind finding out how much of your income you are liable to pay the government.
In my how to read tax brackets post, I use an example of a lady named Jess (filing single) that makes $95k/year. She owes the government $19,637 – this is her tax liability. If Jess maxed out a 401(k), she would reduce her taxable income by $18,000 down to $77k. What does this do to her tax liability? Now, she would only owe $15,948.50 saving her $3,688.50 that she can put into her pocket!
This example should motivate you to find any tax advantages available to you based on your individual situation because you can save yourself a great deal of money!
Back to my point regarding why it is important to think about tax planning throughout the year. If you wait until late in the year, it will likely be difficult to implement some of the things I covered in this post. For example, you likely cannot contribute $18k into your 401(k) from your December paycheck. If you can – congrats! You must make really good money 🙂
Here are some ideas that you should think about early each year. Each idea below can help reduce your taxable income and save you money!
Employer retirement plans: 401(k), 403(b), etc.
I already discussed the 401(k) in my example. There are no income restrictions for contributing to a 401(k), so take advantage of saving money into one of these plans.
A traditional IRA is a retirement account that is tax deductible. The limit for 2016 is $5,500 ($6,500 if you are over 50 years old) that you can contribute. You can write off this $5,500 if you make under $61k as a single filer or 98k as a married filer. There is a sliding scale for how much you can write off if you make more than these limits.
Health Savings Accounts
If your employer offers a high-deductible health plan, you may want to consider it because of the advantages of the Health Savings Account (HSA). I wrote a post on all of the advantages of an HSA, which you can find here.
I recently discovered an additional advantage of the HSA: if you pay for you medical expenses out of pocket instead of using your HSA right away and you continue to invest money in your HSA, you can later reimburse yourself with money from your HSA. Read more on the IRS site. You are taking advantage of your money growing tax-free and you are pulling it out tax-free…. Very nice 🙂
Home mortgage interest payments
Please ensure that you writing off any interest that you pay on your home mortgage. This is pretty straightforward – you should receive a statement from your mortgage company that summarizes how much you paid in interest payments for the current tax year.
Children are an excellent tax exemption. For 2016, the tax deduction is $4,050. I went to graduate school with a gentleman that has 12 children. If he made $100k/year his tax liability (filing married jointly) would go from $16,542.50 down to $6,782.50 – that is $10k in savings! Now, I do not advocate having 12 children. That decision is up to you and your wife.
Finally, it is important to plan because all of the money you receive in a refund is essentially an interest-free loan you are providing to the government. I know and I’ve heard some people argue that they don’t care – they like the “surprise” of the money from a tax refund. Don’t fall into that category – take control of your finances and plan ahead.
Take advantage of your money and keep as much of it as possible. You make the decision on what to do with your money – don’t let the government!
Do you tax plan throughout the year?
Or do you have a plan that you only need to tweak minimally each year? If so, share what you do!