Could you be missing out on tax-savings opportunities?

Many people do not prepare for the impact of taxes on their investment and retirement accounts until they have been negatively affected by them. As we move into tax season, now is a great time to begin thinking about strategic and tactical tax planning for 2021 and beyond. Over the next several weeks we will be posting some valuable tips on how to cut or minimize taxes.

Tip #1 – Taking advantage of employer sponsored savings plans

401(k) – A 401(k) is a defined contribution retirement plan. These accounts are comprised of “pre-tax” employee earnings (thus reducing taxable income), as determined by the participating employee, and, potentially, a contribution match as chosen by the employer. Usually the employee will be able to choose from a predetermined list of options for how the contributions are invested and any profits on the selected investments grow tax-deferred. Therefore, taxes on the account are not paid until a distribution is made and, at that point, the full distribution will be taxed at the taxpayers current income rate. However, the potential savings arises from taxpayers waiting to withdraw funds until retirement years, when they will likely be in a lower tax bracket than during working years.

Currently (2021) employees can contribute up to $19,500 to their 401(k), and anyone age 50 and over is eligible for an additional catch-up contribution of $6,500. The limit on total employer and employee contributions in 2021 is $58,000 ($64,500 with catch-up contribution).

Roth 401(k) – A Roth 401(k) is also a defined contribution retirement plan and accounts are comprised similarly to a traditional 401(k), with both employees and employers able to contribute. However, the portion of employee earnings are contributed “after-tax” (unlike the 401k above in which the contributions are made before taxes). Advantages of the “after-tax” contributory nature is that the earnings also grow tax-free. What does this mean for distributions? It means that if you contribute to a Roth 401(k) for 5 years and start withdrawals after age 59 ½, you can take out any amount tax and penalty free.

HSA – A HSA (Health Savings Account) allows employee earnings to be set aside on a pre-tax basis to pay for qualified medical expenses. Qualified medical expenses include deductibles, copayments, and coinsurance, along with other predetermined expenses paid by the taxpayer. A taxpayer may only contribute to an HSA if they have a qualified High Deductible Health Plan. If their employer does not provide the option for opening an HSA through a company plan, the employee may open their own account, provided they meet the criteria.

The HSA contribution limit for 2021 is $3,600 for self-only coverage and $7,200 for family coverage; with a catch-up contribution of $1,000 for age 55 or older. A unique feature of an HSA is the funds roll over to the next year if not spent and earnings in the account are tax-deferred. Due to their ‘triple threat’ tax savings, these accounts can create long term advantages, as the funds in an HSA can follow a person/family into retirement. As retirement is often a time when healthcare becomes a large portion of living expenses it is often wise to consider your options for investing your HSA account and to try to avoid spending any funds pre-retirement, so the account can continue to grow for your future needs.

FSA – A FSA (Flexible Spending Account) allows an employee to contribute a portion of their earnings on a pre-tax basis to pay for qualified medical expenses, such as: medical and dental services, glasses and vision care, some over the counter medications, and prescriptions. In 2021, the annual contribution limit per employee is $2,750 and a spouse can also contribute $2,750 through their employer. Unlike an HSA, FSA accounts are only available through an employer and funds are usually ‘use it or lose it’ within that plan year. However, in 2021 new rules were created that gave employers the option to allow one of two rollovers: 1) A maximum of $550 in unused funds to be rolled from 2021 into the following plan year or 2) A grace period of up to 2.5 months for employees to use the money. Both of these options are discretional for the employer to offer.

If you are fortunate to be working for an employer that sponsors these types of savings plans, taking advantage of them is a great way to possibly lower your taxes while instilling savings discipline!

Want to learn more tax savings tips? Keep an eye out for upcoming tips to include:

• Paying attention to available tax credits – often people are unaware of tax credits available to them and how to best use them
• Using Tax Losses – Known as tax-loss harvesting, this can be an effective way to minimize taxes from one year to the next
• Open a Donor Advised Fund (DAF): A DAF, is a great way to lower your tax base while offering flexible opportunities to donate to charities and nonprofits of your choice
• Tax Efficient Investing: There are definitely was to invest that are advantageous from a tax-perspective depending upon your individual situation. This is affected by total assets (including property), individual tax bracket, international holdings, long and short term objectives just to name a few.

DISCLOSURE: The material above is for informational purposes only and should not be interpreted as legal, tax or financial advice. Always consult your CPA/tax advisor/attorney to discuss your specific situation.