Paying taxes is inevitable, but smart financial planning can help you minimize your total lifetime tax bill. In this blog post, we’ll explore five strategies that can help you retain more of your hard-earned money over the long run. These tactics include funding a Health Savings Account (HSA), utilizing backdoor Roth IRA contributions, gifting appreciated stock, completing Roth conversions during down income years, and tax loss harvesting. Let’s dive into each of these methods in detail.
Fund Your Health Savings Account (HSA)
An HSA is a tax-advantaged tool that can help you reduce your tax bill while saving for future medical expenses. Contributions to an HSA are tax-deductible, and the growth of your investments within the account is tax-deferred, and qualifying medical distributions are tax-free. To qualify, you must have a high-deductible health plan (HDHP).
By funding your HSA, you can lower your taxable income, potentially reducing your tax liability. In 2023, the funding limits are as follows regardless of income:
- Family – $7,750
- Single – $3,850
- Over 55 – Additional $1,000 catch-up contribution
If the funds are not used for medical expenses they will be taxed as income and if used prior to 65 there will also be a 20% early withdrawal penalty. One planning option would be to pay for medical expenses out of pocket, save your receipts, and you can reimburse yourself at any time.
Ex: John incurs $10,000 worth of medical expenses from 2019-2022 but pays for all expenses out of pocket. In 2023, he has a need to come up with $10,000 and can reimburse himself for the expenses he has incurred tax free.
Utilize Backdoor Roth IRA Contributions
High earners often find themselves ineligible to contribute directly to a Roth IRA due to income limits. However, they can take advantage of the “backdoor” Roth IRA strategy. This involves contributing to a traditional IRA and then converting it to a Roth IRA.
As long as you don’t have any other pre-tax IRA accounts, the conversion of the contributed funds is tax-free. In 2023, the funding limits are $6,500 per person with an additional $1,000 per person as a catch-up contribution for those over the age of 50. Those under 59.5 will want to be cognizant of the 5 year aging rule for converted funds if there is potentially a need to access funds as there can be a 10% early withdrawal penalty on those funds.
Gift Appreciated Stock
If you’re looking for ways to reduce capital gains taxes, consider gifting appreciated stock to charity. When you gift appreciated assets, you can avoid paying capital gains tax while also getting an itemized tax deduction for the value of the stock on the day it is gifted.
For those looking to complete multi-year charitable planning, utilization of a donor advised fund can allow you to further reduce your tax bill.
Complete Roth Conversions in Down Income Years
During years when your income is lower, such as retirement prior to Social Security and RMDs, a gap year, or a down year in the market consider taking advantage of Roth conversions. By converting a portion of your traditional IRA or 401(k) into a Roth account, you’ll pay taxes on the converted amount at your current, potentially lower, tax rate. This can result in substantial tax savings over your lifetime, especially if you anticipate higher income in the future.
Tax Loss Harvesting
Tax loss harvesting is a strategy for reducing your tax liability on investments. It involves selling investments that have experienced losses to offset gains from other investments. By strategically realizing losses, you may be able to reduce your taxable income and potentially lower your overall tax bill. Be mindful of IRS rules regarding wash sales, which restrict repurchasing the same or substantially identical securities within 30 days.
Reducing your lifetime tax bill doesn’t always require complex financial maneuvers. These five strategies—funding an HSA, utilizing backdoor Roth IRA contributions, gifting appreciated stock, completing Roth conversions, and tax loss harvesting—can have a significant impact on your overall tax savings. However, it’s crucial to consult with a qualified tax professional or financial advisor to tailor these strategies to your unique financial situation and goals. By being proactive and making informed decisions, you can keep more of your money in your pocket and secure a financially stable future.
Disclosure: Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.
Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional.
Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.
Like Traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free.
IRA tax deductibility and contribution eligibility may be restricted if your income exceeds certain limits, please consult with a financial professional for more information.
Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.
Donors are urged to consult their attorneys, accountants or tax advisors with respect to questions relating to the deductibility of various types of contributions to a Donor-Advised Fund for federal and state tax purposes. To learn more about the potential risks and benefits of Donor Advised Funds, please contact us.
