Five Strategies for Lowering Your Taxable Income
Brought to you by Your Money Line
One of the most common financial concerns is how to lower taxes among individuals. Whether you are working or retired, you can lower your taxable income in multiple ways. While you should always consult with a tax professional on your specific financial situation and which makes the most sense for you, below are a few things to consider when looking to lower your taxable income.
If you are actively working:
● Contribute to a Retirement Plan.
The most straightforward way to reduce your taxable income is to save for retirement. You can save for retirement through an employer-sponsored plan or a Traditional Individual Retirement Account (IRA). With an employer-sponsored plan, like the Tax-Deferred Retirement Account 403(b), pre- tax contributions reduce employees’ income for that tax year before taxes are applied. If you have an Traditional IRA, contributions may be deducted from your tax return, reducing the taxes owed in the tax year of that contribution.
● Make HSA Contributions.
A Health Savings Account (HSA) allows pre-tax contributions for healthcare costs. HSA’s are only available to employees with high deductible health insurance plans.
● Make FSA Contributions.
Your employer may offer a Flexible Spending Account (FSA) that allows money to be kept away pre-tax for expenses like medical bills. An FSA provides a way to reduce taxable income by setting portions of earnings aside in a separate account managed by your employer.
If you are actively working or retired:
● Consider Your Charitable Donations.
Whether you’re working or retired, charitable donations can help offset your taxable income by contributing to your itemized deductions. If you are already making charitable donations and you are still taking the standardized deduction, you might be missing out on a tax benefit. Consider making donations to causes you agree with, such as Ministerial Relief and Assistance, to increase your itemized deductions. If you are retired and are 70½ or older, you also have the option of making a Qualified Charitable Distribution (QCD). A QCD is more commonly referred to as “IRA to charity” where one chooses to transfer money from an IRA to an eligible charity. Charitable donations are a great way to reduce your taxable income while also contributing to causes you are passionate about.
If you are retired:
● Make Sure to Balance Your Pre/Post-tax Withdrawals.
In retirement, you pay taxes on any distributions that were made on a pre-tax basis during your contribution years. Contributions to a regular 403(b) account come out of your paycheck before the IRS takes it’s cut. This is known as pre-tax withdrawal, which means you won’t pay income tax on those contributions, and it can reduce your adjusted gross income.
Contributions made to a Roth 403(b) are known as post-tax withdrawals, for allowing the saver to pay in money after it's taxed. This means your contribution can be withdrawn without taxes and penalties in retirement, giving you a lot of flexibility.
With both types of these accounts, you can be strategic with how you use them. Contributing to a pre-tax account now may mean your investment and earnings will be taxed at a lower rate in retirement. After you reach age 73, you must begin taking required minimum distributions (RMDs) from certain tax-advantaged retirement accounts such as 401(k)s and IRAs. The amount of your distributions is based on factors such as your age and account balance.
But, outside of these rules, you largely have control over when and how to withdraw funds. If there's a year when you expect your income to be lower, you may want to take larger taxable distributions from your accounts during that time so the money can be taxed at a lower rate.