Don’t Leave the IRS a Tip: The Importance of Tax Planning and Reviewing Your Return

Don’t Leave the IRS a Tip: The Importance of Tax Planning and Reviewing Your Return

| January 07, 2022
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You work hard to build wealth, and the last thing you want is for something to eat away at your hard-earned money. One of the best ways to retain more of your wealth is to reduce the burden of taxation. And this isn’t something to deal with once a year when tax day comes; ongoing tax planning can help you strategically reduce your tax bill so the IRS doesn’t get more of your money than they should. 

If you understand the rules of the game, you will have a much higher success rate at winning. The same is true for understanding tax law. If you understand tax law and the benefits available to taxpayers, then when it comes to “winning the game” of reducing your tax bill, you will be that much better off. Here’s how to make that happen.

Create a Tax-Efficient Retirement Plan

When working with your advisor to create your financial plan, retirement planning will often be a key point of conversation. By stress-testing your plan, you can quickly see if your current retirement accounts, savings rates, and other assets will be adequate for the retirement lifestyle you desire.

A direct way to reduce your tax bill is to contribute money into tax-deferred savings accounts, such as a 401(k) or IRA. But in order to maximize your savings, you will need to determine both your current cash flow needs and your ideal retirement income. A financial plan will look at both factors and determine the best way to use your tax-deferred savings accounts to save you money both now and in the future. For example, a $50,000 withdrawal from a Roth IRA will have a wildly different tax impact than that same distribution from a traditional IRA. Creating a tax plan can help you strategically withdraw from your various retirement accounts and reduce your tax liability. 

Contribute to a Health Savings Account

As a refresher, health savings accounts (HSAs) offer a triple-tax savings. It may sound too good to be true, but HSAs have no federal income tax, no state or local taxes, and no Federal Insurance Contribution Act (FICA) taxes. If you are eligible for an HSA, your money will be tax-deferred and can be withdrawn tax-free to pay for medical expenses. 

Because HSA account balances simply roll over from year to year, by contributing to the limit each year, you can build up quite a nest egg to cover either current medical expenses or future medical expenses in retirement. Think of it as a Roth IRA for medical expenses. For 2022, HSA owners now have higher contribution limits to help them do just that. If you have individual coverage, you can contribute $3,650, and for family coverage, your limit is $7,300, with an extra catch-up contribution of $1,000 available for those over age 55. (1) If you can’t max out the yearly limit, attempt to contribute enough to cover your deductible and take advantage of your employer match, if available. 

Use a Roth IRA to Transfer Wealth

Roth IRAs are an attractive savings vehicle for many reasons, including no required minimum distributions (RMDs), tax-free withdrawals after age 59½, and the ability to pass wealth tax-free to your heirs.

You probably know the effects taxation can have on your assets and the inheritance you hope to pass on to future generations. For example, if you passed down a traditional IRA, non-spouse beneficiaries used to be able to stretch out the distributions from that account over the beneficiary’s life, but now they have to liquidate the account within 10 years of inheriting it (with some exceptions), thanks to the new SECURE Act. This significantly decreases the value of the account due to the amount of taxes paid in a short time. 

But if you pass down a Roth IRA instead, there is no income tax due on the distributions as long as the account is held for more than five years and the account holder is 59½ or older. 

If you have traditional IRAs already or earn too much to qualify for a Roth IRA, consider a Roth conversion to remedy the tax loss. The basic process to convert your IRA is to withdraw the amount you’d like to invest in a Roth, pay the tax owed on the distribution, then reinvest it into a Roth account. Be sure to work with a professional to determine the best time to do this so you don’t push yourself into a higher tax bracket or be forced to use funds from the account to pay the extra taxes on the distribution. Also, stay on top of potential tax changes that could limit the availability of this option for you. (2)

Deduct Eligible Charitable Contributions

Annual gifts to qualified charitable organizations may be deemed an eligible itemized deduction. Under the Tax Cuts and Jobs Act, fewer taxpayers itemize deductions due to the doubling of the standard deduction. (3) Regardless, charitable giving is still a useful tax-minimization strategy.

In order to benefit from charitable giving, you’ll have to plan ahead. With the new higher standard deduction, you’ll need to make sure your total deductions for the year, giving included, exceed $12,550 for an individual filer, and $25,100 for married filing jointly. (4) If your deductions fall below this amount, consider bunching your giving or doing several years’ worth of giving in one year.

You may also want to look into using a donor-advised fund to combine all charitable contributions in a year and then distribute the funds to various charities over several years. With this strategy, you may be able to itemize deductions in one year and take the standard deduction in the following years so you can achieve a tax benefit that you may not have received otherwise.

Review Your Previous Tax Returns

You can learn a lot from the past. Look at your previous tax returns with a professional to search for deductions or credits you may have missed, opportunities to lower taxable income, and plan for the next tax season. Take these factors into consideration when making a tax plan for the future: 

  • Review notable tax law changes for 2021 that may affect you.
  • Review your capital gains and losses.
  • Review your retirement savings options.
  • Consider Roth IRA conversions.
  • Consider additional year-end tax strategies.
  • Understand potential tax law proposals.

Getting Ahead With Tax Planning

Tax planning could potentially save you money, both today and in the future, but while beneficial, taxes can be complicated—it’s estimated that it would take you eight weeks of nonstop reading to get through the lengthy and complicated IRS tax code, which is filled with various opportunities and strategies for optimal tax efficiency. (5) The key is partnering with an experienced professional who can help you understand how each possible opportunity works and how it fits into your strategy and long-term goals. 

With years of experience in financial and tax planning, our HBA Wealth team knows how to implement appropriate tax-minimization strategies to help you save more of your hard-earned money. If you have questions about any of these tax strategies and whether they’d be right for you, we encourage you to reach out to us. Contact us at (626) 529-8347 or email Ricky directly at ricky@hbawealth.com to get started. 

About Haydel, Biel & Associates

Haydel, Biel & Associates is an independent financial advisory firm serving individuals and families near Pasadena, California. The firm was founded in 2004 by Chris Haydel and Ricky Biel with a desire to provide unbiased, client-centered, community-based financial advice. Together, they have built a practice that has grown into a family of caring, smart professionals committed to blending proven investment methodologies with creative financial technologies that make it easier than ever to accomplish your goals. They strive to keep things simple and fun to give their clients peace of mind and alleviate financial stress. HBA Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the HBA Wealth team may be able to help, contact them today at (626) 529-8347 or email Ricky directly at ricky@hbawealth.com.

The commentary on this blog/website reflects the personal opinions, viewpoints and analyses of the Haydel Biel & Associates employees providing such comments, and should not be regarded as a description of advisory services provided by Haydel Biel & Associates or performance returns of any Haydel Biel & Associates Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Haydel Biel & Associates manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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(1) https://www.irs.gov/pub/irs-drop/rp-21-25.pdf

(2) https://www.cnbc.com/2021/11/19/house-passes-build-back-better-act-retirement-plans-for-the-wealthy.html

(3) https://www.cnbc.com/2019/06/18/post-tax-reform-charitable-contributions-took-a-hit-in-2018.html

(4) https://www.forbes.com/advisor/taxes/standard-deduction-2021-2022/

(5) https://irisreading.com/how-long-would-it-take-to-read-the-entire-u-s-tax-code/

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