There’s no reason why April should be the worst month on your calendar. We get it, filing tax returns is stressful. You know you have to report everything, but you don’t want to increase your taxable income. If you invest wisely and use these investing hacks, you can save some cash in a smart and legal way.
Now, let’s get to it.
1. Boost your retirement savings
One of the best ways to lower your tax bill is to reduce your taxable income. You can put up to $18,500 in your 401(k) per year.
If you’re concerned about skyrocketing taxes in the future, switch to a Roth 401(k). Unlike a regular 401(k), you don’t get a tax break when your money goes into the account.
However, withdrawals will be tax-free, while cash coming out of a regular 401(k) would be taxed in your top bracket. If you’re new to all of this, no worries, just check out this blog article about retirement accounts.
2. Fund an IRA
If you don’t have a retirement plan at work or you want to increase your savings, you can stash a max of $5,500 in an IRA.
Depending on your income and whether you participate in a retirement savings plan at work, you may be able to deduct some or all of your IRA contribution from your tax bill. Or, you can choose to forgo the upfront tax break and contribute to a Roth IRA that will allow you to take tax-free withdrawals in retirement (yep, just like the Roth 401k).
3. Income tax deferral
This strategy is focused on taking the disposable income you plan on saving throughout the year and setting it aside to be taxed at a later date.
For example, tax-deferred annuities have no IRS contribution limits and are not subject to RMDs (required minimum distributions), like a 401k or IRA.
4. Dividend tax deferral
For investors who don’t have an IRA or 401(k), a tax-deferred investment vehicle may prove useful. These investments defer all dividends and capital gains.
Just like a retirement plan, you get taxed when you take distributions from the plan. When using these investing hacks, your future income is taxed as earned income. To have maximum tax deferrals, an individual must defer distributions until he or she reaches 59.5 years old (as in 401(k)s/IRA plans.)
5. Switch up your donations
If you plan to make a significant gift to charity, consider one of the most clever investing hacks. giving stocks or mutual fund shares you own that have increased in value. By donating these investments, you avoid paying taxes on the capital gains of these securities.
The deduction on your tax return will be the market value of the securities on the date of the gift, not the amount you paid for the asset, and you never have to pay tax on the profit. However, don’t donate stocks or fund shares that have gone down in value. You’d be better off selling the asset, claiming the loss on your taxes, and donating cash to charity.
6. Sell losing investments
Any excess losses can offset other capital gains, and if you have more overall losses than gains you can use up to $3,000 to reduce your taxable income. Beyond that, any excess losses can be carried forward to future tax years.
That said, only sell a stock if it truly doesn’t work for your portfolio anymore. Don’t do it just to get a tax break, because if you change your mind and buy it back within 30 days, the IRS can take back your deduction.
7. Contribute to a health savings account
A health savings account, or HSA, is designed to help Americans with high-deductible health plans save for medical expenses. While there are certain qualifications you must meet to enroll, these contributions are tax-deductible and are invested on a tax-deferred basis.
If you withdraw the funds to pay qualified medical expenses, your withdrawals will be tax-free as well, no matter how much your investments have grown.
8. Save for college the tax-smart way
More of one of the investing hacks, this one is a saving hack.
Use a state-sponsored 529 College Savings Plan or Coverdell Education Savings Accounts, and let your college savings grow tax-deferred until needed. Although your contributions are not tax-deductible (they are made after-tax dollars), earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college.
As of January 1, 2018, tax-free withdrawals may also include up to $10,000 in tuition expenses for private, public, or religious elementary and secondary schools (per year, per beneficiary). And don’t worry, if one child decides not to go to college, you can switch the account to another.
9. Take advantage of irregular streams of income
When your taxable income is high, make greater contributions to retirement accounts that give you deductions. When it’s low, consider selling investments at a gain or converting traditional retirement accounts to Roth accounts.
10. Think about your allocation strategy
Tax-inefficient investments, like taxable bonds and bond funds that distribute income, still belong in tax-deferred accounts such as IRAs and 401(k)s. Tax-efficient investments should be held in a taxable brokerage account. In other words:
- Keep interest-producing investments inside of tax-free and tax-deferred retirement accounts. Interest income and short-term capital gains are taxed at a higher rate than long-term capital gains and qualified dividend income. And in retirement accounts, these aren’t reported as taxable income. The only time they’re reported is when you make a withdrawal.
- Keep capital gains and qualified dividends producing investments outside of retirement accounts. If they’re inside a retirement account, you’ll never get the advantage of the lower tax rates on this type of investment income, as all withdrawals from tax-deferred retirement accounts are taxed at your ordinary income tax rate.
Bonus tip
From a tax perspective, there’s a huge difference between doing something on December 31st and doing it a day later. If you know an upcoming expense is going to be tax-deductible, think about whether you can pay for it this year rather than next year.
Taking care of January’s mortgage payment in December, for example, could give you an extra month’s worth of mortgage interest to deduct for that year.
The takeaway
We know you’ve got many things to consider when investing; risk, returns, dividends, fees, etc. However, these investing hacks will make your life easier.
Understanding taxes is an important component of a smart money management strategy. Make good use of tax-favored accounts and investments so you can improve your chances of owing the IRS less.
