Income taxes are often one of our largest
expenses and a source of deadline-induced stress and confusion. While
we cannot avoid paying taxes without getting some unwanted attention
from the IRS, we can at least try to minimize the total amount of income
taxes that we owe. The good news is that by paying less in taxes,
you’ll have more money available to save for your financial goals and
use for more fulfilling life pursuits. The new tax code may have
eliminated many seldom used deductions and significantly changed some
others, but there are still several easy ways for you to reduce your
taxable income – even things you may be doing already. Here are 7 easy
tax saving strategies that can lower your 2018 or 2019 tax bill:
This is an option if you are working but not covered by a qualified plan at work (e.g., 401k or 403b) or if you are participating in a plan and have income below certain limits. You can contribute up to $5,500 (or $6,500 if you turned 50 or older last year) to an IRA for 2018. If you don’t have a retirement plan through work or do but meet the income limits, you can deduct your contributions to a traditional IRA and invest them to grow tax-deferred until withdrawn.
A Roth IRA is an alternative to deductible contributions (or if you don’t qualify). In fact, the Roth IRA may be a better alternative if you do not need the last-minute tax savings or anticipate being in a higher tax bracket during your financial independence years. Contributions to a Roth IRA aren’t deductible, but the account can grow to be tax-free after 5 years and age 59 ½. Unlike a traditional IRA, you also have the flexibility to withdraw your contributions (but not any earnings) at any time without tax or penalty.
Max out your health savings account (HSA) contribution.
A frequently overlooked last minute tax saving strategy is to contribute more to your HSA for the previous tax year. First, you must be covered by a high deductible health insurance plan to qualify. Then, if you didn’t contribute up to the maximum annual limit of $3,450 for individual coverage or $6,900 for family coverage during 2018, you may have some extra tax savings available.
Just be sure to notify your HSA provider that you want your contribution to be coded for the 2018 tax year. Your contributions will be included as an adjustment to gross income, which will work to lower your taxes. As a best practice, you should also use this tax season as an opportunity to review your HSA contribution plans for the remainder of 2019.
Set aside education funds in a 529 plan.
This strategy particularly makes sense if you live in a state that offers state tax incentives for 529 plan contributions. SavingforCollege.com provides a guide that shows which states offer residents state tax deductions or credits for 529 plan contributions. Contributions to 529 college savings plans may not give you as significant tax savings as you will likely get from a 401(k), deductible IRA, HSA, or FSAs, but you can still realize some tax savings for money dedicated to education-related expenses. 529 plan assets grow tax-free when used for qualified education related expenses. In addition to using a 529 when paying out of pocket college costs, you may also be able to use 529 plan assets for K-12 private education costs.
If you are still itemizing deductions, don’t miss any potential deductions or tax credits!
The number of households itemizing deductions for the 2018 tax year will go down significantly from previous years. This is because you are allowed a standard deduction of $12,000 for single filers ($12,200 in 2019) and $24,000 ($24,400 in 2019) for married couples filing joint returns. Homeowners can still deduct their mortgage interest on Schedule A of their 1040 form, but the amount is subject to mortgage limits. A significant change is that now you may only deduct up to $10,000 of state, local and property taxes (or sales and property taxes if you don’t live in a state that has income taxes). Medical expenses can be deducted for 2018 if they exceed 7.5% of your adjusted gross income (increasing to 10% for this year).
There are also deductions available for cash and household items donated to charities. One strategy related to charitable contributions is to consider bunching contributions to occur every other year if you are close to the standard deduction limit. In any case, be sure to keep receipts for those donations.
Contribute to an employer-sponsored retirement plan.
Making pre-tax contributions to a retirement plan at work is one of the best ways to boost your retirement savings and reduce your taxable income. 401(k) and 403(b) contribution limits increased slightly to $19,000 per year in 2019. If you are covered by a retirement plan at work, you can use tax planning season to proactively review your contributions for the rest of the year. At a minimum, verify you are at least contributing enough to capture your employer’s match (if provided). On a similar note, if you are fortunate to work for an employer offering bonus or incentive income, you may be able to defer income to a lower tax year.
Take advantage of a flexible spending account (FSA) at work for medical and/or childcare expenses.
If you already know that you will have ongoing expenses related to childcare or out of pocket health care expenses, why not receive some tax breaks for these types of expenses? Healthcare flexible spending account limits increased to $2,700 in 2019. The contribution increase is also applicable to limited-purpose FSAs that are restricted to dental and vision care services and can be used along with health savings accounts (HSAs). In either case, don’t overfund it since it’s “use it or lose it.” (If you have extra funds at the end of the year, you may want to stock up on things like prescription drugs or contact lenses.)
The Dependent Care FSA (DCFSA for short) is another tax saving account where you choose to automatically have money deducted from each of your paychecks BEFORE TAX is taken out, which you can then use to pay for child care expenses that year. The IRS allows you to set aside up to $5,000 each year, regardless of how many kids you have. Just be aware that this is a family, not individual, limit and that it’s also “use it or lose it.”
Create a personal spending plan to create bigger tax savings.
Your personal spending plan (a.k.a. “the budget”) plays an important role in your income tax planning. (Yeah, I get it. You’re probably getting tired of hearing the “you need a budget” message, but the awareness of your current and future spending plans will allow you to identify the resources you dedicate to these tax saving strategies.)
Coming up with a list of potential ways to save money on taxes is easy. Following through with putting those plans into action is the real challenge. That is where the personal spending plan becomes so important. By identifying exactly how much you can afford to redirect to tax advantaged accounts and purposes that will help you reach your life goals, you will be able to proactively prepare for future tax seasons with confidence.
Paying taxes isn’t always the most exciting item on our to-do lists. Taking a more proactive approach to the tax planning process can help you focus your time and energy on the things that matter the most to you and minimize the taxes you pay along this journey. (If you want to see some of these tax saving alternatives in action, you can use this Pre-Tax Savings Calculator to estimate how much these financial moves could lower your income taxes.)
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