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Tax Planning: Strategies to help you save more for retirement

Tax Planning: Strategies to help you save more for retirement

April 15, 2024

Time to pay the tax man! The date is upon us and more quickly for some than others. If you owe money, it comes too quickly. The purpose of this article is to help you find ways to plan your taxes over time, with strategies for reducing them while saving more for your financial goals.

One thing all financial goals have in common is that they all require money to achieve them. Most of us have a limited amount of money, so we may not have enough to achieve all our goals. Therefore, when allocating our income and savings to goals, we may need to either produce more money to achieve them or change or eliminate some of them.

One way to produce more money is to find ways to reduce expenses. According to the Tax Foundation, the average income tax rate in 2021 was 14.9%, while the top 1% paid 25.9%, which is almost eight times higher than the 3.3% average rate paid by the bottom half of taxpayers. In fact, the top half of taxpayers paid 97.7% of all federal income taxes. If you feel the tax pain every year, you may be one of those highly taxed individuals or families, and this posting should be helpful.

You may be wondering whether it is morally or ethically right to avoid paying taxes. A famous commentator, Arthur Godfrey, once noted that, “I'm proud to pay taxes in the United States; the only thing is, I could be just as proud for half the money." The IRS clearly distinguishes between tax avoidance and tax evasion. While the IRS seeks to find and prosecute those who commit tax evasion, they also state that, “Taxpayers have the right to reduce, avoid, or minimize their taxes by legitimate means.” The point is that you should reduce your taxes by every legitimate means possible. Why would you pay more taxes than you are required to pay?

To that end, here are several ways you might try to reduce your taxes and free up money for other goals:

  • Maximize retirement contributions. This may sound easy, but there are many ways to contribute to retirement that do not reduce your taxes. If you have a 401k or other qualified plan at work, you may be able to reduce your income by contributing to that plan. An IRA contribution might be another way to reduce your income. However, if your income is high, keep in mind that there is an income phase-out that may reduce or eliminate your ability to claim your IRA contribution as a deduction. Collaborate with your financial advisor, CPA, or tax professional to create a plan that works well for your situation. For more information on those income phase-outs, as well as other tax information, check out these helpful videos. There are a couple of strategies to consider, regarding retirement contributions:
    • Roth vs. Traditional. This is the most common question I get, when collaborating with clients, “Should I do a Roth?” On the surface, this sounds like a simple question. However, there are several things to consider. There are income limits for contributions to a Roth IRA but not with a Roth 401k. There are contribution limits for both. There is a 5yr rule for taking distributions from a Roth. You should also think about whether you can get a deduction on an IRA contribution or whether you even need one. Planning can include Roth conversions or backdoor Roths. If you want a great quick read on this, check out this article, “Traditional vs. Roth IRA.”
    • Catch-up Contributions. For taxpayers ages fifty and over, the IRS allows catch-up contributions to retirement plans. The new IRA contribution limit for 2024 is $7,000, and the catch-up contribution is still $1,000. However, the latest SECURE 2.0 Act of 2022 added a cost-of-living adjustment for future changes. For 401(k), 403(b), and most 457 plans, participants fifty and older can make $7,000 catch-up contributions, for a total maximum participant contribution of $30,500, starting in 2024.
  • Invest in municipal bonds or municipal bond funds. In most cases, the interest from municipal bonds is tax-free at the federal level. You may also be exempt from state and local taxes if you live in those areas where the bonds are issued. Some municipal bond funds are created for specific states and localities to give you an abundance of options. However, there are several potential pitfalls that taxpayers often fail to consider with municipal bonds. Keep in mind that investing involves risk including loss of principal. No strategy assures success or protects against loss. Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply. The following is only a partial list of some other potential pitfalls:
    • De minimis rule. This rule applies to municipal bonds purchased at a discount to the market. If greater than 0.25% per year from the time of purchase to maturity, gains from the discount are taxed as ordinary income (Municipal Securities Rulemaking Board: Tax and Liquidity Considerations for Buying Discount Bonds, Nov. 2023)
    • Increase in taxation of Social Security Benefits. While not subject to federal taxes, the income from municipal bonds is used to calculate your modified adjusted gross income (MAGI), which determines how your Social Security benefits are taxed. Up to 85% of Social Security benefits may be subject to income tax, if half of an individual’s benefit plus their income – including tax-exempt interest – exceeds $34,000 for an individual or $44,000 for married couples (How Muni Bond Holdings Can Affect Social Security Income, J. Kuepper, May 6, 2016).
    • Increase in Medicare Premiums. Your MAGI can also affect how much you pay for Medicare Part B and prescription drug coverage. If you are married filing jointly with a MAGI greater than $206,000 or an individual with a MAGI greater than $103,000, you will pay higher premiums. Details regarding MAGI and the impact on Medicare premiums can be found on the Social Security website here.
    • Alternative Minimum Tax (AMT). There are two methods to calculate income taxes, and they are both calculated at the same time. The first method is calculating ordinary income taxes, and the other is calculating the AMT. The higher of the two is what is used or paid. The AMT disallows many of the deductions that are allowed under the ordinary tax code system. For more information on how this could affect your taxes, visit the IRS website here.
  • Charitable Donations. Donations to qualified charities can reduce your taxes. One way you may consider donating is through Qualified Charitable Distributions (QCD). These are payments made directly to qualified charities from your retirement accounts and are available to taxpayers seventy½ or older. Taxpayers must make the contributions directly from their IRA and the amount can be their full required minimum distribution (RMD), up to $100,000, if the taxpayer is age 73 or older. The amount that is contributed is fully deductible from your income and counts toward your RMD. This is an effective strategy if you are charitably inclined and not using your full RMD. There are also several ways to use trusts and annuities for charitable donations that allow immediate or gradual tax deductions while retaining control of the assets. That is an overly complex subject that requires an in-depth review beyond the capacity of this post. However, you can find out more in this article, “Trends in Charitable Giving.”
  • Use a Health Savings Account (HSA). These accounts offer triple benefits regarding taxes. Contributions are tax-deductible, earnings grow tax free, and withdrawals for qualified medical expenses are tax-free. If you have a high deductible health plan (HDHP) at your workplace, you qualify for an HSA. This is a personal savings account that allows you to put aside money to pay for qualified medical expenses. However, many people overlook the tax-deductible/tax-free benefits. Many of these accounts can be invested in portfolios and can grow tax-deferred, based on the underlying investment’s performance.

The above tax strategies are just a few ways high-earners may be able to reduce their income taxes. If your income is in that category and you are paying a lot of money to the IRS every year, you may benefit from an in-depth advanced tax-planning analysis. While your tax advisor or CPA is calculating your taxes, they may have overlooked some of the complex ways you can structure your business or income. That is what differentiates tax planning from tax advice. Tax planning is the sharing of “what if” scenarios and general educational information on how tax strategies relate to your situation and goals. Tax advice is the clear “how to” recommendation of specific strategies, plans for implementation, as well as guidance throughout the process.

If you were hit hard with taxes this year, or if you think your situation will get more complex over the next few years or into retirement, you may benefit from a detailed analysis and tax plan. At Milligan Wealth Management, we work with our LPL Financial Tax Planning Team of CPAs and tax attorneys to analyze your situation. We then craft a plan that you can review with your CPA for implementation. For complex estates, we also engage our Advanced Planning Team of estate and tax attorneys to coordinate a plan of action that is specific to your unique situation. Reach out to us and let us know if we can help.

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Milligan Wealth Management and LPL Financial are separate companies.

LPL Financial does not provide tax or legal advice; consult your tax or legal advisor regarding your particular situation.