Although it’s been pushed back to July 15, Tax Day 2020 will be here sooner than you know! Paying taxes is never fun – but Libertyville, Illinois residents can take a number of steps to lower them. All it takes is a bit of planning. Here are a few tax-savings strategies:
1. Contribute to an IRA
Contributions to a traditional individual retirement account (IRA) are one of the best ways to lower your tax bill for the year. The Internal Revenue Service (IRS) allows total yearly IRA contributions of $6,000 every year. (1) The figure rises to $7,000 if you’re 50 or older. For example, let’s assume you are married with $100,000 of annual household income. The maximum traditional IRA contribution will reduce it to $94,000, meaning you’ll be taxed on $94,000 rather than $100,000. *Note that there are caveats and phaseouts to IRA contributions. If your income is too high or you or a spouse are covered by an employer-sponsored retirement plan, you may be ineligible to contribute (2).
These contributions are deductible whether you itemize deductions or not. Yearly contributions can also be made up to the tax filing deadline for the year, rather than the end of the calendar year. In other words, you have until July 15, 2020, to make a traditional IRA contribution for the tax year 2019. *Note, in every year EXCEPT 2020, contributions must be made by April 15
Investors should be aware that only traditional IRAs are tax-deductible upon contribution. Roth IRAs are made from income that has already been taxed. The tax advantages of Roth IRAs kick in upon retirement when withdrawals are not taxed, but contributions to them won’t help you immediately this year. (Withdrawals from traditional IRAs, on the other hand, are taxed at retirement.) Funds in both types of IRA grow tax-free until withdrawal.
2. Take all the deductions you can
The standard deduction was raised significantly as a result of the 2018 Tax Cuts and Jobs Act (TCJA). For 2020, the standard deduction is (3) if you are married and filing jointly.
But taking all the deductions you can has the potential to save you on taxes, as long as they exceed the standard deduction.
Here are some of the more common deductions:
- Interest on your mortgage, up to $750,000. While this is lower than the $1 million limit prior to the TCJA, it is still significant for many people (4)
- Property taxes, up to $10,000. (5) This can combine property taxes with state and local taxes (SALT). For many Illinois homeowners, this deduction, although lower than levels prior to the TCJA, can lower overall taxes.
- Qualified medical expenses, as long as they are more than 7.5 percent of your adjusted gross income (AGI) in 2019. This threshold will rise to 10 percent of AGI in 2020. (6) Medical expenses include insurance premiums paid, any amount you paid out of pocket for medical care, prescriptions, devices, and transportation to and from places of treatment.
- Charitable contributions. You can itemize cash, goods, or stock donated to qualified charitable organizations. It’s a good practice to go through your closets and attics to find clothes or other goods (such as toys or sporting equipment) that are in good condition but longer used, to maximize your contributions to charities.
- Especially for 2020, you can donate to charity even if you claim the standard deduction. That’s right, as a part of the CARES act, anyone may claim a $300 above-the-line deduction for charitable contributions, instead of those who itemize and claim charitable deductions. This is very valuable, as it reduces your taxable income before your AGI is calculated. (7)
- Student loan interest. Student loan debt has risen precipitously across the U.S. in the last decade. Interest on student loans is deductible in many circumstances.
- 529 savings plans. States offer 529 savings plans for qualified higher education expenses, including your children’s eventual tuition and living costs. Contributions are tax-deductible.
3. Utilize available pretax health savings accounts
Several employer-sponsored health savings accounts can help you save on taxes, not by constituting potential deductions, but by lowering your income via pretax payroll deductions.
FSA withdrawals can be used for payment of medical care, insurance premiums and dependent care, (9) subject to certain limitations. If you contribute $2,000 and your salary is $65,000, for example, the contribution will reduce your taxable income to $63,000.
FSAs do have a potential drawback, however, which is that money you don’t use within a certain period often needs to be forfeited. The most common periods are 12 or 15 months. In other words, if you contribute $2,000 but end up only using $1,500 from your FSA account, you will not have access to the extra $500 past a certain time limit. “Use it or lose it” applies, so be sure you calculate future expected FSA-qualified expenses carefully.
Some employers offer Health Savings Accounts (HSAs), another type of health savings plan that lowers your income via pretax deductions. HSA participants must have a high deductible health plan to qualify. If you do qualify, however, you can save much more than in an FSA. The 2020 HSA limit is $3,550 for individuals; it’s $7,100 if you have a family. In addition, people who are at least 55 can contribute $1,000 above these limits annually.
Plus, HSAs are not using it or losing it. You can keep HSA funds in your accounts for years, until and past retirement. Once HSA plan holders are 65, they can use the money for any purpose, not simply health expenses. If you do use the money for something other than medical and healthcare costs at that point, though, the withdrawals will be taxed at an ordinary rate.
4. Contribute the maximum to your 401(k) going forward
Be sure to strategize to save the maximum amount on taxes for the future.
If your employer offers a 401(k) plan, contribute the maximum amount you can. Traditional 401(k) contributions are taken out pretax, so they can lower your taxable income considerably.
For 2019, the maximum total 401(k) contribution is $19,000. (10) For 2020, it is climbing to $19,500. Folks who are 50 or above can contribute an extra $6,000 in 2019, which will rise to $6,500 in 2020. Many employers match 401(k) contributions up to 100 percent of employee contributions, which is an additional boost to your retirement savings – and free to you!
Like IRAs, 401(k)s also come in traditional and Roth forms. Note that only contributions to a traditional 401(k) are pretax and thus will lower your taxes in the year of contribution. Roth 401(k) contributions are made with money that has already been taxed.
Roth 401(k)s are also tax-advantaged, but the tax benefit for them is that you will not be taxed on qualified withdrawals. You will be taxed at your then-existing tax rate for traditional 401(k) withdrawals. Funds in both types of 401(k)s grow tax-free until withdrawal.
For more information on tax savings strategies, contact Prism Planning Partners today!
(1) IRS Retirement Topics – IRA Contribution Limits, IR-2018-211, November 1, 2018, https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits
(2) Folger, Jean. “Roth and Traditional IRA Contribution Limits for 2020”, January 21, 2020. https://www.investopedia.com/retirement/ira-contribution-limits/
(3) Standard Tax Deduction: How Much Is It in 2019-2020 and When to Take It https://www.nerdwallet.com/blog/taxes/standard-deduction/
(4) Frankel, Matthew CFP. “Here’s the 2020 IRS Standard Deduction – and What it Means to You” The Motley Fool. 7 Nov 2019. https://www.fool.com/taxes/2019/11/07/heres-the-2020-irs-standard-deduction-and-what-it.aspx
(5) Orem, Tina “Property Tax Deduction Rules and How You Can Save More” NerdWallet April 10, 2019, https://www.nerdwallet.com/blog/taxes/property-tax-deduction/
(6) Intuit-Turbo Tax Can I Claim Medical Expenses on My Taxes? Updated for Tax Year 2019 https://turbotax.intuit.com/tax-tips/health-care/can-i-claim-medical-expenses-on-my-taxes/L1htkVqq9
(7) McQuitty, Susannah. “COVID-19 Relief Strategy – CARES Act Allows $300 Above-the-Line Charitable Donation Deduction” 1040.com. 3 Apr 2020. https://www.1040.com/blog/2020/4/3/covid-19-relief-strategy-cares-act-allows-300-above-the-line-charitable-donation-deduction/
(8) IRS Eligible employees can use tax-free dollars for medical expenses IR-2019-184, November 15, 2019, https://www.irs.gov/newsroom/irs-eligible-employees-can-use-tax-free-dollars-for-medical-expenses
(9) Intuit TurboTax 5 Ways to Reduce Your Taxes for Next Year Updated for Tax Year 2019 https://turbotax.intuit.com/tax-tips/tax-planning-and-checklists/5-ways-to-reduce-your-taxes-for-next-year/L6GdbL33N
(10) IRS 401(k) contribution limit increases to $19,000 for 2019; IRA limit increases to $6,000 IR-2018-211, November 1, 2018 https://www.irs.gov/newsroom/401k-contribution-limit-increases-to-19000-for-2019-ira-limit-increases-to-6000