How did you do with your 2018 tax bill? Did you pay more or less tax in 2018 than you did in previous years?
Whether you were a beneficiary of the 2017 Tax Cuts and jobs Act or not, now is a good time to begin tax planning for the year ahead.
Below are 5 ideas to help you pay less tax this year.
Adjust your withholdings. A lot of people got stung with a bill from the IRS when they completed their 2018 tax return. In some cases, there may have been a penalty for underpayment of your Federal income tax.
To avoid this problem in 2019 you will need to adjust the amount of tax withheld from your paycheck (or IRA distribution, pension amounts, etc.). Knowing exactly how much to withhold is tricky. To help taxpayers get an idea of how much tax to withhold from their paycheck, the IRS has created a Withholding Calculator. You can find it here.
A word of warning, completing the calculator has been criticized as being nearly as difficult as completing the tax return itself. However, entering the inputs now while your tax info is fresh in your mind will help.
Start an IRA. Everyone with earned income from a job can contribute to an IRA. Not everyone can deduct their IRA contributions from their taxable income. For your contribution to be tax deductible, your income needs to fall within a certain range and you may not qualify if you have a qualified retirement plan at work.
If you and your spouse are covered by a retirement plan at work (most people are), click here to get an idea if you will qualify to deduct an IRA contribution next year.
If you or your spouse are NOT covered by a retirement plan at work, click here for more information.
Consider a Roth IRA. Roth IRAs are never deductible, but contributions grow tax deferred and distributions are generally tax-free after age 59 ½. Roth IRAs won’t help you reduce your taxes this year, but they can play a key role in keeping your taxable income down in retirement.
Besides, if you are going to save and invest for the future, why not use an account that is tax free?
Increase your 401(k) or retirement plan contribution. If you are age 50 or older this year, the IRS allows you to contribute an extra $5,000 to your retirement plan making for a maximum contribution of $24,000.
If you work for a state or local government and participate in a 457 Deferred Compensation plan, the contribution limits can be even higher. The contribution amount on a 457 plan is the same as a 401(k), $19,000. However, the catch-up contribution allows employees over age 50 to contribute up to $38,000 a year during the final three years preceding retirement.
Pay more tax now. Tax accountants, financial planners and others have long counseled their clients to minimize and defer taxes as long as possible. This is still good advice, most of the time.
For retired people in lower tax brackets over age 59 1/2, it may make sense to take distributions from pre-tax retirement plans and IRAs, and pay the tax now rather than later.
This is because at age 70 ½ the IRS forces IRA owners to take out a “Required Minimum Distribution” or RMD.
By age 70 or so, you will also be receiving any Social Security and any pension benefits to which you and your spouse maybe entitled. Combine that with your IRA RMD and your taxable income could rise significantly, possibly forcing you into a much higher tax bracket.
If you are in the 12% marginal Federal income tax bracket today, your IRA distributions could end up being taxed at 22% or more in the future. What’s more, the current tax rates are set to expire at the end of 2025 making it possible that both tax rates and tax brackets could be higher in the future even if your income isn’t.
Meet with your financial or tax advisor. Federal and state income taxes may be your largest single expense, even more than healthcare and your mortgage payment combined. Providing your financial advisor with a copy of your tax return and reviewing your tax situation helps them help you keep this expense under control.
Retirement income planning and managing your tax burden can be complicated. Reviewing your tax return, anticipating future income needs and sources, and creating a long-term plan to minimize taxes is the key to a solid financial plan.
Talk to your financial advisor and/or tax professional to determine a long-term tax strategy that makes sense for you and your family.