April is right around the corner. And we all know April brings more than just spring showers. But what if, instead of owing money to the IRS, you received a refund? Fortunately, there are some simple strategies you can use to maximize your tax savings.
Tax loss harvesting is the selling of underperforming stocks and other securities in your portfolio to offset the gains from other stock sales. Usually this strategy is used near the end of the calendar year, but it can be implemented at any time within the tax year. But remember, if you buy back the same stock within 30 days, the IRS can disallow your deduction.
Health Savings Accounts (HSAs) are triple tax-advantaged accounts created to save on medical expenses that an individual’s health plan does not cover. Contributions are made into the account by the account holder or the account holder’s employer and are limited to a maximum amount each year. The contributions are invested over time and can be used to pay for qualified medical expenses, including dental, vision and over-the-counter drugs. Contributions made to and HSA tax-free, grow tax-free and have tax-free distributions.
A dependent care Flexible Spending Account (FSA) is similar to an HSA but is used to pay for childcare expenses for children 12-years-old or younger, or qualifying adults who cannot care for themselves and meet specific IRS guidelines. Up to $5,000 can be set aside using pre-tax dollars and the funds can be used to pay for before- and after-school care, day care, private preschool and day camps. However, FSAs have a “use it or lose it” policy. Some employers may offer a grace period of up to 2 ½ months (March 15) into the following tax year, but it is best to plan how much is deposited into an FSA to avoid any possible losses.
There are several different types of retirement vehicles, some tax-deferred (such as traditional IRAs and 401(k)s) others tax-exempt (Roth IRAs and Roth 401(k)s), that you can use to maximize your tax savings. The challenge is deciding which is right for you.
Traditional IRAs (Individual Retirement Accounts) allow individuals to contribute pre-tax income into an account that grows tax-deferred. However, note that contribution limits do exist. Distributions can be taken penalty-free from a traditional IRA beginning at age 59 ½, but mandatory minimum distributions begin at age 72. No taxes are assessed on the account until the beneficiary makes a withdrawal, allowing the contributed pre-tax dollars to grow tax-deferred. The goal is to wait until retirement to begin withdrawing distributions so that the withdrawals are taxed at the beneficiary’s current tax rate, typically much lower than pre-retirement.
401(k)s are employer-sponsored defined-contribution plan. If your employer offers a 401(k), you can opt to invest a percentage of your income into the plan and the contribution is tax deductible in the year the contribution was made. Similar to a traditional IRA, 401(k)s do have restrictions on withdrawals. Distributions can be taken penalty-free beginning at age 59 ½, but mandatory minimum distributions begin at age 72. No taxes are assessed on the account until the beneficiary makes a withdrawal, allowing the contributed pre-tax dollars to grow tax-deferred.
Roth IRAs are similar to traditional IRAs, but the money contributed to a Roth IRA is made with after-tax dollars and the contributions are not tax deductible as they are in a 401(k). The money continues to grow, tax-free, and can be withdrawn tax-free. Roth IRAs are a great strategy to use if you believe your tax rate will be higher in retirement than it is currently. However, there are limits for contribution, both in terms of who can contribute and how much can be contributed. In 2020, the income limit for those filing individually is $139,000 and $206,000 for those married filing jointly. In addition, the contribution limit in 2020 is $6,000 per year for those 50-year-old or younger and $7,000 per year for those over 50.
Roth 401(k)s are a hybrid, combining the best parts of a traditional 401(k) with a Roth IRA. They allow for contributions made directly from an employee’s paycheck with after-tax dollars, but the distributions are not subject to income tax, like a Roth IRA. Roth 401(k)s do not have an income limit for participation and an annual maximum contribution of $19,500, so people with higher incomes can still participate. Participants are also able to take a loan from a Roth 410(k) of up to 50% of the account balance or $50,000, whichever is smaller. However, if the loan is not paid back per the terms of the agreement, the loan could be considered a taxable distribution.
As with any strategy used to maximize tax savings, the key is to understand the pros and cons of each strategy and to use those strategies that will have the best impact for you, both in the short- and long-term. Tax Saving Professionals can help you identify the strategies that will offer you the most tax-savings and guide you through the strategies available to you to maximize your tax savings and ensure that you have the proper documentation to legally take all the deductions to which you are entitled. To learn more, call us at (772) 257-7888.