By now, you might have completed your tax returns for 2016 … and for some of you, the joy of getting your taxes out of the way is lessened by how much you owe the IRS.
If it makes you feel any better, a big tax bill is a sign you made a lot of money last year! But I know that coughing up a few thousand bucks in the next few weeks is a pretty crappy way to celebrate your success.
What if I told you that you can legally lower what you owe in taxes, possibly by thousands of dollars? And not only will this reduce your bill for future years — you still have time to lower it for 2016, too.
Here are some ways to hold onto more of your money:
1. Employer-Sponsored Retirement Plans
If your company offers 401(k)s, 403(b)s, TSPs, or SIMPLE IRAs, you can contribute to those accounts with pre-tax dollars (and possibly get a company match — free money!). While your take-home pay will be lower, your taxable income will be lower as well.
As an added bonus, you won’t owe taxes on that money until you withdraw it in retirement. That means it’ll grow tax-deferred for decades! And if you’re in a lower tax bracket in retirement than you are now, you’ll pay lower taxes on your withdrawals.
Keep in mind that Roth contributions are made with after-tax income, so your contributions to that type of account won’t lower your taxable income.
2. Individual Retirement Accounts
Contributions of up to $5,500 per year to a traditional IRA can be tax deductible. If you’re a single filer and you’re not covered by an employer plan, then your contributions to a traditional IRA are tax deductible.
What about if you’re married filing jointly? If neither you nor your spouse have an employer-sponsored retirement plan, your traditional IRA is fully deductible if your income doesn’t exceed the $196,000 limit (it’s partially deductible if your combined income is between $186,000 and $196,000). If either you or your spouse do have a retirement plan at work, incomes over a certain amount might result in a partial deduction, or none at all.
If you’re self-employed or you do freelance or contract work, you can contribute to up to 25% of your pre-tax income (or up to $54,000, whichever is lower) to a SEP-IRA. (Talk to your CPA or tax accountant to find out the exact amount you can contribute to a SEP-IRA. The actual calculation is more complex.)
Here’s where you can save on your 2016 taxes: you have until April 18, 2017 to make contributions to traditional IRAs and SEP-IRAs for the previous tax year. I recently suggested a friend of mine do this because both she and her husband earned income through contract work in 2016, and they lowered their tax bill by $1,500 by maxing out SEP-IRAs!
If you’d like to learn more about employer-sponsored and individual retirement accounts, check out my online course, Smart & Easy Retirement Planning for Millennials!
3. Health Savings Accounts (HSAs)
If your health insurance is a High Deductible Health Plan (HDHP), you can open a Health Savings Account (HSA) to set money aside to pay for health care costs.
I’m a huge fan of HSAs because they offer a triple tax benefit. Your contributions are made with pre-tax income, which lowers your tax bill for the year. You can invest the money in this account and the earnings on these investments grow tax-deferred. And if you withdraw money to pay for qualified medical expenses? It’s tax-free!
Many people use their HSA as another type of retirement account, because after you turn 65 you can withdraw your money for any reason (not just for medical expenses) without paying a penalty, though you’d have to pay taxes on the withdrawals in that case.
For 2017, you can contribute up to $3,400 (individual) or $6,750 (family) to an HSA. You have until April 18th to make a contribution for 2016. The limit was $3,350 in 2016 for individuals and there was no change for the family contributions.
4. Company Benefits
Pay attention during open enrollment, because some benefits your employer offers might mean tax savings for you.
Flexible Spending Accounts (FSAs) are a way to set pre-tax dollars aside for medical and childcare expenses. You can contribute up to $2,550 to an FSA and $5,000 per family ($2,500 for Head of Household filers) to a Dependent Care FSA in 2017.
Some companies allow you to use pre-tax income to pay for commuting expenses, like bus and train passes. Check with your benefits or HR department to see if they offer commuter benefits.
An Unexpected Additional Benefit to Lowering Your Taxable Income
I often recommend saving for retirement in both pre-tax and taxable retirement accounts, like Roth IRAs. This way, when you’re retired and withdrawing money from those accounts, you can take money out in a more tax-efficient way. You can contribute up to $5,500 per year.
However, Roth IRAs have income limits that can affect how much you can contribute. Here are the income limits for 2017:
- For single filers: Once you earn $118,000-$133,000, you’ll only be able to contribute a reduced amount. If you earn $133,000 or higher, you can’t contribute to a Roth IRA at all.
- For married taxpayers filing jointly: once you earn $186,000-$196,000 combined, you’ll only be able to contribute a reduced amount. If you earn $196,000 or higher, you can’t contribute.
If you’d like to make a Roth IRA contribution for the 2016 tax year (you have until April 18 to do this, too), the income limits are slightly different:
- For single filers: Once you earn $117,000-$132,000, you’ll only be able to contribute a reduced amount. If you earn $132,000 or higher, you can’t contribute.
- For married taxpayers filing jointly: once you earn $184,000-$194,000 combined, you’ll only be able to contribute a reduced amount. If you earn $194,000 or higher, you can’t contribute.
If you earn more than the income limit, lowering your taxable income could bring you below the limit and allow you to contribute to a Roth IRA after all.
Ask for Help When You Need It
The government offers various tax breaks to encourage responsible behavior like saving for retirement, so use these tax breaks to your advantage! You might need to enlist the help of a CPA as your tax situation becomes more complicated.
It can be tough to keep track of all the ways your actions can affect your tax liability. I recommend working with an accountant or financial planner because they can help you take a big-picture view of your finances and suggest ways you can save.
