Top 3 Tips for Lowering Your Taxes
Even though they happen every year, it is easy to get caught off guard by taxes. Budgeting for taxes is difficult because you typically do not know how much you owe until the end of the year. Even if your work schedule remains the same from year to year, tax laws may change or you may be eligible for different tax deductions.
Budgeting for taxes is about more than setting aside money to pay for taxes. When you budget, you also want to find ways to lower how much you owe. There are many different ways to reduce your taxes each year. The top three methods for lowering your taxes include strategically putting money into your retirement account, making the most out of tax credits and funding your Health Savings Account.
Contributing to Your Retirement Account
Contributing to your retirement account is a great way to prepare for the future, but it also helps you out in the present. There are multiple tax deductions available depending on what retirement account you use. The rules are slightly different depending on the account as well. It can also change depending on your other retirement benefits.
One of the most common ways to save for retirement is through a Roth IRA fund. With a Roth IRA fund, you choose how much money you place into the account, with the money collecting interest and growing over the years. You are allowed to defer the first $6,000 you place into a Roth IRA fund each year. You are allowed to make IRA contributions for the year up until the tax filing deadline each April, so you can plan how much you want to put into your IRA to get the maximum benefits on your taxes. If you already have a retirement plan through work, such as a 401(k), you may not be eligible for a full deduction. Check with either your employer or use the IRS worksheet to determine how much you can deduct in these circumstances.
If you do have a 401(k) plan from your employer, there are additional savings available. With most 401(k) plans, you have the option to increase how much money is placed into the account. Placing more into the account gives you a larger tax break. As of writing, the maximum amount you can defer paying taxes on is $19,500.
When you turn 50, there are additional savings for both IRAs and 401(k)s. You are allowed to defer an additional $6,500 on your 401(k) and up to $7,000 to your IRA. This is known as a catch-up contribution. No matter your age, if you made less than $75,000 for the year, you can get deductions for both your IRA and 401(k). This limit is increased to $124,000 if you file as a married.
Maximizing Tax Credits
Another way to cut down on how much you pay in taxes each year is through tax credits. Tax credits allow you to make a reduction in the overall amount of taxes you owe. This is a dollar-for-dollar reduction, so if you owe $10,000 and have $1,000 in tax credits, you end up paying $9,000. Tax credits are sometimes mistaken with tax deductions. While the two terms are similar, there is a big difference. With a tax deduction, you reduce how much income you report, which in turn lowers your tax payment. This is applied before all the tax calculations. Tax credits are applied after the calculations, typically leading to a larger savings.
There are many types of tax credits available. Typically, the best way to maximize your tax credits is by working with a tax account or financial advisor, who knows all the credits to look for and which ones to prioritize. Most tax software also checks your filing for eligibility. These programs only check for a limited number of credits, but they prioritize the largest ones, such as the Earned Income Tax Credit.
Tax credits fall into a number of categories. Some tax credits focus on child care or dependent costs, allowing you to get a credit equal to a certain percentage of what you spend on daycare or babysitting costs if you work during the day. Other credits focus on education, such as the Lifetime Learning Credit, which offers a credit as high as $2,000 if you pursue a post-secondary education. There are also available tax credits based on insurance, as well as retirement-based tax credits. If you work from home, which many employees had to do in 2020 due to Covid-19, you may be eligible for additional tax credits.
Health Savings Account (HSA)
An HSA is a tax-advantaged savings account used for any out-of-pocket medical expenses. Some employers offer an HSA as a workplace benefit, putting a set amount of your paycheck into the account. With some plans, you can also deposit your own money into the account. Any money deposited into the account does not count towards your income tax. Many employees place money into the account towards the end of the year to fall into a lower tax bracket, allowing them to spend less on taxes overall, while also building a buffer to help with future medical expenses. In 2020, the maximum you can deduct for your HSA is $3,550 as an individual, or $7,100 if you have a family limit. Both limits increase by $1,000 if you are 55 or older.