Understanding Tax Planning
The importance of tax planning goes beyond keeping cash out of Uncle Sam’s hands. You’re also preparing yourself for a secure retirement. Here are a couple of tax planning tips that are easy to do.
Here’s the very first thing the tax experts at Kiplinger stress to readers about tax planning: This is not a game just for the wealthy. Tax planning will save you money.
I’m most certainly not wealthy at this stage of my career, but I’m not going to get rich by giving away more money to Uncle Sam every year than I need to. So I’m happy and eager to do some tax planning, but what does that really mean?
Just because I work at Kiplinger doesn’t mean I’m an expert (yet!) in tax planning, but I’m surrounded by several friendly experts (and their writings). Follow me as I explore the topic -- with a goal of trimming my tax bill next spring by more than $100 thanks to some newfound tax-planning tips. You’ll come away with an understanding of the basics of tax planning so that you can make some smart money-saving moves of your own.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The tax bill you owe each spring is based on the working, saving, investing, spending, business and other personal decisions you make during the year. At its core, tax planning revolves around reducing what Uncle Sam considers taxable income to let you save or spend more of your money. For me, a childless, healthy single person, that means reviewing my retirement and health savings account contributions -- my best bets for tax breaks that can reduce my taxable income. (Others can apply tax-planning principles to college costs, their home, their healthcare and other big-ticket expenses.)
Boosting retirement savings is a great way to not only build for the future, but to also score a tax-planning win without too much difficulty. For example, let’s assume you make $50,000 per year and make no contributions to your 401(k); you’d face a $6,790 tax bill, leaving you with $43,210 in take-home pay -- and no money stashed away for your future self.
Now, let’s consider a 401(k) contribution of 4%, or $2000. Your taxable income would be reduced to $48,000, and Uncle Sam’s cut will fall to $6,350.
And if you boost retirement savings to 6%, or $3,000, that lowers your taxable income to $47,000 -- for a savings of $220 on your tax bill. Take a look at how you pay Uncle Sam less and pay yourself more as you increase your 401(k) contributions:
Base Salary | 401(k) Contribution Percentage | Contribution Amount | Taxable Income | Federal Tax Owed | Take-Home Pay | Total to You (including 401(k) funds for your future self) |
$50,000 | 0% | $0 | $50,000 | $6,790 | $43,210 | $43,210 |
$50,000 | 4% | $2,000 | $48,000 | $6,350 | $41,650 | $43,650 |
$50,000 | 6% | $3,000 | $47,000 | $6,130 | $40,870 | $43,870 |
Your tax savings are multiplied if you also boost contributions to a health savings account. A health savings account is a powerful tool to cover out-of-pocket medical expenses: HSA contributions are tax-deductible (just like 401(k) contributions), contributions made by your employer are excluded from your taxable income, the funds grow tax-deferred in the account, and withdrawals are tax-free for qualified medical expenses, without a time limit. In 2020, you can contribute up to $3,550 if you have self-only coverage or up to $7,100 for family coverage if you are enrolled in a health plan with a deductible of at least $1,400 for self-only coverage or $2,800 for family coverage.
For 2021, I plan to boost my 401(k) contributions by 1 percentage point. As a tax-planning move, that will save me more than $100 in taxes next year. Better to save that money for the day I stop working than to hand it over to Uncle Sam. My HSA? I'm holding off on making funding decisions for 2021 until the end of the year, so I can better forecast my health expenses for the year ahead.
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
Rivan joined Kiplinger on Leap Day 2016 as a reporter for Kiplinger's Personal Finance magazine. A Michigan native, she graduated from the University of Michigan in 2014 and from there freelanced as a local copy editor and proofreader, and served as a research assistant to a local Detroit journalist. Her work has been featured in the Ann Arbor Observer and Sage Business Researcher. She is currently assistant editor, personal finance at The Washington Post.
-
Is a Phased Retirement Right for You?
Want to keep working, just not as hard? A phased retirement may just be the answer.
By Kimberly Lankford Published
-
Four Tips to Make Your Sales Presentation a Winner
Being prepared and not being boring can go a long way toward persuading a potential customer to buy into what you’re offering.
By H. Dennis Beaver, Esq. Published
-
'Instant' EV Tax Credits Are a Hit: $580M Paid This Year
EV Credits Claiming federal electric vehicle tax credits at the point of sale is a new and popular option in 2024.
By Kelley R. Taylor Last updated
-
Retirees Face Significant Tax Bills Due to Fraud
Fraud A new report sheds light on how older adult scam victims end up with big tax bills and lost retirement savings.
By Kelley R. Taylor Last updated
-
Tax Day: Is the Post Office Open Late?
Tax Filing Tax Day means some people need to mail their federal income tax returns.
By Kelley R. Taylor Published
-
High Earners: Beware of These Illegal Schemes to Lower Taxes
Tax Schemes The IRS says high-income filers are targets for several illegal tax schemes.
By Katelyn Washington Last updated
-
Mailing Your Tax Return This Year? What to Know Before You Do
Tax Filing There are plenty of reasons not to mail your tax return this year, but here’s what you should know if you are.
By Katelyn Washington Last updated
-
IRS Warning: Beware of Smishing and 'Helper' Tax Scams
Scams Tax season is a time to look out for email and text message scams.
By Kelley R. Taylor Last updated
-
Most Expensive States to Live in for Homeowners
Property Taxes High property tax bills make the places on this list the most expensive states for homeowners to live in.
By Katelyn Washington Last updated
-
Don’t Miss This $2,500 Tax Break for Paying Your Student Loan
Tax Deductions Do you qualify for the student loan interest deduction this year?
By Katelyn Washington Last updated