Over the course of your life, you might spend thousands of hours monitoring your investments and savings.
But how much time do you spend on tax planning?
Filing your taxes is a chore and a bore.
But their complexity (and the potential return on your time investment) means you have-to plan for them (sometimes years in advance) to save as much money as you can.
View it as an opportunity.
Here are 4 tips that could help you keep more of your money in 2020, and beyond.
1) Are you withholding the right amount?
The United States’ income tax system is considered “pay-as-you-go.”
This means you pay, either via payroll withholding or estimated payments, as you earn the money.
But as a rule, should you withhold high or low?
Neither is ideal.
The problem with under-withholding is that the IRS can hit you with interest charges and even additional penalties.
And, yet, overpaying offers you absolutely no benefit (it’s not like the government pays you interest).
Sure, refunds are nice. But they’re merely returning your hard-earned money.
Besides, overpaying not only impacts your cash flow, it keeps that money from working for you.
Here’s what you should do: Do your taxes earlier this year.
When you meet with your accountant, have him or her analyze your withholding so that you can make any adjustments, and so the government isn’t taking too much, nor too little.
2) Time for some pre-emptive itemization.
As we’re more than two years into the new tax law, you’re probably starting to understand the impact of the changes.
The new law makes advance tax planning even more essential. Speak with your accountant to get a handle on whether you’ll be claiming the standard deduction, or itemizing, in 2021 (for the 2020 tax year).
Here’s why:
The standard deduction is going up a bit in 2020 to $12,400 for single filers, and to $24,800 for married people filing together.
If your charitable contributions are low this year (2020), and you’re a joint-filer, the new tax law’s higher standard deduction practically makes taking it a no-brainer.
But, looking forward, with a little creativity, you can still make charitable donations in a tax-friendly way.
Called “bundling,” if you expect your contributions will be reasonably high this year, you might want to accelerate your donations (by making next year’s 2021 contributions now).
Simply, even for middle class filers, once your contributions hit a certain threshold, then itemizing (as opposed to taking the standard deduction) can still save you money on taxes.
There are numerous complications and considerations. Talk to your accountant early this year and find out if this is a good strategy for you.
3) Counter your investment losses.
2019 ended with a booming market, but that doesn't mean it was great for everybody.
Despite the boom, some investors still lost money.
Did you know under certain circumstances you can use $3,000 worth of investment losses to counter gains from either ordinary income or other investments?
One way to do this is—if you are still employed and received a raise (or bonus) for 2020—claim an investment loss to balance out some of the increase in taxes you’ll be required to pay.
Making a mistake here can be costly, so you need to know exactly what you’re doing.
Using a certain type (and amount) of loss to cancel out a specific type (and amount) of gain is best achieved with the help of a credentialed tax professional.
4) “Time” your RMDs
RMDs are how the government ensures you liquidate a percentage of the savings in your retirement accounts (so they can tax it).
They don’t want you sitting on all that cash forever.
But there’s been a few changes to the laws regarding retirement account contributions and RMDs.
Due to the implementation of December 2019’s SECURE Act, as of 2020, required minimum distributions (RMDs) on tax-deferred plans kick in when you turn 72 instead of 70½.
However, IF you turned 70½ before December 31st, 2019, not only are you not impacted by this change to the law, and still required to take your first RMD by April 15th of 2020 (just as if the new law didn’t exist), even if the above is you, and you don’t turn 72 until 2021, you’re locked into taking RMDs from now on, just due to the anomaly of turning 70½ in the last half of 2019.
Another SECURE Act change is that, beginning in 2021, almost everyone with taxable income will now be able to once again, if they so choose, contribute pre-tax money to their IRA until they stop working.
To clarify: You used to have to stop making contributions to tax-deferred retirement accounts once RMDs kicked in. That is no longer the law. If you have taxable income (there are other stipulations and considerations), you can continue making contributions to your IRA for as long as you like.
Here’s another consideration: Most people love to let their tax-deferred retirement accounts grow and grow for as long as is legally possible.
And with the SECURE Act adding another 18 months of tax-deferred growth?
Letting it ride sounds like a no-brainer.
However, if your 72nd birthday is still a way down the road, and you have other savings, you might want bite the bullet and lower the balances in your tax-deferred retirement accounts before spending your other money.
Many great savers end up paying thousands of extra dollars in taxes because they didn’t realize they should’ve started drawing from their tax-deferred retirement accounts well before RMDs kicked in.
That’s because the amount of the RMD is based on the balance in your retirement account.
The larger the balance, the higher the RMD, and, typically, the higher amount you’ll have to pay in taxes.
To repeat, depending on your tax bracket, if age 72 is still out in the distance, and you haven’t touched your retirement accounts?
It might be financially advantageous to start.
Conclusion
Tax planning used to be an easy-to-ignore component of financial planning.
Not anymore. (Which is why, rather than merely give tax planning recommendations, we’ve added accounting, bookkeeping, and tax planning services under the Allworth Financial umbrella.)
There’s money to be saved.
Tax planning is like mountain climbing: Mistakes are costly, but the satisfaction of a perfect climb can make all the effort worthwhile.
