Many people dread tax season. The idea of digging through all of your financial records, working through the filing process, and hoping you submitted everything correctly to avoid an audit is stressful.
And the worst part? It kind of feels like you can’t win. If you have your employer withhold too much money from your paychecks for taxes, you’re essentially giving the government an interest-free loan (even if the refund is a fun windfall). On the other side of the equation, if you underpay on our taxes over the course of the year, you could owe a significant amount of money.
As much as we may wish that we could wave a magic wand and have the tax season stress eliminated from our lives – that’s not a real possibility. As the old quote from Benjamin Franklin goes, “Nothing can be said to be certain, except death and taxes.”
If we can’t avoid dealing with taxes, we need to find positive ways to incorporate them into our financial plan. Luckily, there are a few things you can do to lower your taxable income and make next filing season easier.
Check Your W-4
According to NerdWallet’s 2018 Tax Study, only 35% of Americans are aware that they can adjust their federal tax withholdings anytime over the course of the year. Your withholdings can help you to adjust the amount of taxes you pay out of your paychecks to ensure that it’s correctly calculated based on your current income and your total number of exemptions you claim.
As your lifestyle changes over time, the information on your W-4 should change. For example, if you don’t claim your spouse, children, or other dependents on your W-4 as exemptions, you might consider making adjustments to reflect your current living situation.
Look to Reduce Your Taxable Income
If paying taxes overwhelms or frustrates you, you may be able to take advantage of a variety of savings accounts that help you to save money on your taxes. These accounts also help you to achieve long term financial goals – like growing your wealth for retirement planning, saving for your children’s college education, or covering medical expenses.
Your workplace 401(k) is a tax-efficient account. In other words, it’s funded with a portion of your income that’s pre-tax. Other retirement savings vehicles that are funded with pre-tax income are:
- 457 plan
- Traditional IRA
- SEP IRA
Using these retirement savings accounts to lower your taxable income is a wonderful way to lower your current taxable income while maximizing your money and preparing for future success.
As a result of the new tax code, 529 Plans are no longer just for college education expenses. Parents can use a 529 plan to fund their child’s education from elementary to high school, as well. However you choose to use the funds in your child’s 529 plan, it’s important to note the tax benefits of these accounts. All earnings from a 529 plan grow federal tax-free, and you won’t be taxed when you or your child choose to tap the account.
Although this account doesn’t technically lower your total taxable income, being able to save for your children’s education and not face a capital gains tax when you finally access the funds is a tax benefit that’s essentially unmatched.
HSA and FSA
A Health Savings Account and Flexible Spending Account are two other key ways to save money on taxes for next year. Although you may need to meet certain healthcare plan requirements to open them, if you’re eligible – they offer another opportunity to reduce your taxable income.
HSAs, in particular, are instrumental in tax efficient financial plans. As they’re funded with pre-tax money, just like your 401(k) or other workplace retirement plan, they lower the amount of income that’s viewed as taxable by the IRS. However, they also roll over from year to year and can be used for qualifying medical expenses.
Whether you have large medical expenses in your future that you’re planning for, or you just want to save for the inevitable increased health-related costs associated with aging, HSAs are an excellent savings vehicle to use.
Get Organized and Speak With a Professional
No matter what strategy you choose to implement, it’s wise to get organized now. Don’t wait until next filing season to get started, you’ll only cause yourself equal amounts of overwhelm and frustration. Instead, stop the cycle by reaching out to a financial planning professional to learn more about these and other options to optimize your finances and reduce tax-related stress.