Tax bills are on the rise: it now takes the average American until April 24th each year to work enough to pay off his or her share of local, state, and federal taxes, as calculated by the nonpartisan Tax Foundation.1 With proper planning, however, you can reduce your income tax burden by maximizing contributions to tax-deferred accounts. This is a common tax-reducing strategy, but investors often underuse it.
With your financial advisor, review your contributions to tax-deferred accounts, and make sure you’re taking advantage of at least one of the following:
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401(k) Contributions.
If your employer offers a 401(k), 403(b), or 457 plan, you can contribute up to $18,000 in 2015. If you are over the age of 50, you can contribute an additional $6,000 as part of a “catch-up” provision. Not only will you be adding significantly to your retirement savings by maximizing your contributions, but you will also lower your taxable income—a definite win-win situation. -
IRA Contributions.
The annual contribution limit for IRAs has not changed recently but stayed constant at $5,500. You’ll need to check with your financial advisor regarding IRA contributions because high earners may “phase out.” -
SEP Plans.
If you own a small business, you and your employees may be eligible for a Simple or SEP IRA. SEP plans only allow employer contributions, but if you’re self-employed, you may be able to contribute up to 25% of your net earnings, and this can have a big impact on your taxes; contributions can be as high as $52,500.
When you maximize your contributions to tax-deferred accounts like the ones mentioned above, you can reduce the amount you pay in taxes now. This is great news, but there’s more. By investing your money in tax-deferred accounts, you can avoid paying taxes on your gains each year and maybe even pay income tax at a lower rate when you withdraw the funds during retirement. Let’s take a look at other benefits of maximizing contributions to tax-deferred accounts.
- You’re less likely to touch the money until retirement. If you access your money before the age of 59 ½, you’ll have to pay a penalty. When you’re saving for retirement, this is a good thing because it forces you to leave your money where it will work for you until you need it.
- You can avoid paying taxes on dividends, interest, and capital gains. Since your account is tax-deferred, your stocks can grow unimpeded by the taxes that normally eat into your gains each year.
- You can invest freely within your tax-deferred account, heedless of worries regarding the ways different types of investments are taxed. You can focus on choosing the most appropriate stocks for your unique financial plan because you don’t have to worry about the tax bill until retirement.2
Maximizing contributions to tax-deferred accounts isn’t the only strategy for reducing your taxable income, but it’s an important one. Discuss the possibilities with your financial advisor, and start off 2016 with a winning strategy for reducing your overall tax bill.
For more information about reducing your taxable income, or for information on other wealth perservation strategies, call one of our Wealth Managers at 1-800-541-7774, or contact us here.
Sources:
2. U.S. News
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.
