The end of the year is closing in fast, and that means there are only a few more weeks to affect the taxes you’ll pay in 2023. You might not start calculating and filing your taxes until March or April, but the decisions you make now can have a significant impact on your tax bill. Even seemingly minor changes to your income, assets, or retirement strategy can affect your taxes next year and beyond.
It’s not always feasible to reduce your tax liability. However, you can’t know what’s possible until you take the time to run the numbers and see how different actions would affect your taxes. A little preparation now can go a long way toward improving the outcome of next year’s tax return.
Take a Look at Your Income
Before you can evaluate year-end tax strategies, you must know your annual income. It’s best if you can figure out exactly what you’ll make this year and what you can expect your income to look like for the next couple of years.
Knowing your income allows you to see which tax bracket you’re in and calculate your potential tax liability. Remember to account for all sources of income, including any money you and your partner make in addition to your salaries. If you’re not sure which types of income are taxable, talk to a financial planner or CPA.
Invest in a 401(k)
One of the most practical and effective tax strategies is to contribute money toward your retirement. Saving for retirement reduces your taxable income and increases the money you’ll have later on; it’s a win-win option.
For many people, the most practical way to save for retirement is to contribute to a 401(k). A 401(k) is a common type of employer-sponsored retirement plan, and many companies will match contributions up to a certain amount. If possible, contribute enough to max out those employer contributions.
If your employer doesn’t offer a 401(k) or if you prefer not to use that option, there are other ways to invest money toward retirement. Some options to consider include a traditional IRA, Roth IRA, solo 401(k), or Simplified Employee Pension IRA. Depending on your income, you can continue to make IRA contributions until the end of the year.
Contribute to a Health Savings Account
A Health Savings Account allows you to save money toward future medical expenses, and the balance in an HSA rolls over into the following year. An HSA also offers tax benefits; you don’t pay taxes on HSA earnings while the money is in the account, and distributions are tax-free as long as you use them to pay for qualified medical expenses. You may only contribute to an HSA if you have a high deductible health plan (HDHP) and no other health insurance coverage.
Contributing to an HSA can be especially important if you’re a high-income earner who doesn’t qualify for many deductions. HSA contributions can reduce your taxable income; your HSA contributions are deductible, and your employer’s contributions are excluded from your gross income. The details of your HDHP determine how much you can contribute to your HSA. For 2022, the limit for those covered by a self-only HDHP is $3,600. If you have a family HDHP, the limit is $7,300. If you’re 55 or older at the end of 2022, you are allowed to contribute an extra $1,000.
Make a Plan for Charitable Donations
If giving to charitable causes is something you value, it’s important to plan out your contributions. There are many different ways to make charitable contributions, and each one can have a different effect on your taxes. In some cases, for example, it may be better to contribute appreciated stock instead of cash. Your financial planner can help you figure out how to maximize the benefits of your charitable donations.
Consider Situational Strategies
Many things can affect your tax burden, and certain circumstances may call for a specific tax plan. For example, if you have a high-paying job that you plan to leave next year, it’s vital to reduce this year’s taxes as much as possible so you don’t have to pay a lot when you have less income. You may need to consider intentionally taking financial losses to reduce your tax burden.
In other cases, it may be beneficial to increase your taxable income. For example, converting a 401(k) to a Roth IRA will result in a one-time income increase, but it will decrease your taxes in the long term.
Another special circumstance involves paying for your child’s college tuition. Your income or retirement distributions factor into FAFSA calculations and can significantly impact the amount of financial aid your child receives.
Special tax cases can be complicated. It’s usually best to work with a financial planner and/or CPA to make sure you understand exactly how your financial plan will affect your taxes.
Preparing Now Can Simplify Your Taxes Next Year
It’s tempting to ignore your taxes until April, but if you start thinking about them now, you can take some steps to minimize your tax bill as much as possible. It’s especially important to consider some of these year-end strategies if you’re getting close to retirement or have significant expenses coming up, such as a child’s college tuition.
Taxes can be complicated, especially when you have to consider investment accounts, charitable donations, and retirement plans. If you aren’t sure how your financial plan affects your taxes, we can help.
The team of financial professionals at Guiding Wealth can work with you to develop a plan that’s built around your goals. We’ll help you figure out how to save for retirement and minimize your tax burden as much as possible. To begin working with a Certified Financial Planner™, schedule a consultation online or call 214-810-3835.