Here we are again the annual fundraiser for Uncle Sam. Some call it rent to live in America. However you like to look at it, apparently it’s one of the only sure things in life along with death. The question is: What can you still do to positively impact your 2021 taxes and what inefficiencies may exist that you can improve on in 2022?
In what follows you will find 4 ideas that you may consider moving forward to take advantage of programs set up by the IRS.
Contribute to an IRA
The IRS wants you to be responsible for your retirement. One way they incentivize you to do this is to save into tax advantaged accounts like IRA’s and 401k’s. The downside on these is that you can’t take the money out until retirement, age 59.5 (unless you qualify for an exception). This is no big deal if you truly are saving this for retirement. The upside is tax deferred or tax free growth depending on the vehicle you choose to use.
If you use a pre-tax account (traditional IRA or 401k) you get a tax deduction for the amount of the contribution you make in the year you do it, then when you take the distribution after age 59.5 you pay ordinary income taxes on any distribution.
If you use a Roth account (Roth IRA or Roth 401k) you get no tax benefit today, however when you take distributions after age 59.5 you pay no taxes on the distribution.
Consider me a nerd, but that is pretty awesome! It is so awesome that the IRS limits you on what you can put in to the account on an annual basis. For 2021 that is: IRA/401k it is $6,000/$19,500 under age 50 and $7,000/$26,000 over age 50. The great news… you can still contribute for 2021 IRA’s up until you file taxes. If that doesn’t excite you than you can probably stop reading this as it very likely won’t get more exciting from here.
Estimate future taxes
So you’re going to get a big refund check this year, huh? Don’t let retail America fool you that this is a great thing! If I or someone else as your financial planner got you 0% return on your money you wouldn’t be thrilled would you? But somehow when the IRS does it we jump for joy.
If it’s possible to get zero as a tax return, then you have planned well throughout the year. If you could invest that money or at worst have it earn a small amount of interest in your savings account you would be better off than letting the IRS borrow it for free. Consider adjusting your withholdings to arrive at the correct amount to net a near zero return.
The government also wants to incentivize you to save for college. One way they do this is by offering 529 plans through your state. Depending on the state there can be state tax benefits to funding a 529. For Arizona residents the state tax benefit is not a lot, but if you were already planning on doing it and the state says they’ll give you a little something it sweetens the pot a little bit!
Regardless of state, there is a federal tax benefit. Funds in a 529 come out tax free if the funds are used for qualified education expenses.
Health Care and Child Care Expenses
Some high deductible health insurance plans offer what is called a health savings account. If you have this your deductible is typically higher on your health insurance than what might be normal, however your premiums typically will be lower. If you have a health savings account you are allowed to put up to $3,600 in as an individual and $7,200 on a family plan (add $1,000 if over age 55). The money goes in pre-tax and comes out tax free if it is used for health care expenses. That is fantastic! It is the most tax efficient account that exists.
Some employers will also offer a dependent care flexible spending account (FSA) where you can save some funds to pay for child care expenses among others. Consult your HR team or accountant to learn more about eligibility of expenses. FSA’s are the type of account where if you don’t use it, you lose it so you don’t want to over save into an FSA.
If you’ve stuck with me this far I’d like to give you a big THANK YOU. As I’m writing this I’m thinking to myself “I don’t know if anyone will read this besides my wife and colleagues who proofread it. I mean I put the word taxes in the title!” I’ve covered a lot of pieces at a high level and my hope is that it is educational and helpful not overwhelming and paralyzing.
If you have further questions on any of the topics covered, other personal finance topics, or would like to suggest a topic for a future post please reach out.