How you plan your finances at the year-end holds the key to efficient tax planning. Making intelligent and timely decisions positively affects the amount of tax you have to pay at the end of the financial year. And if you are saving for retirement, planning to buy a home or a car, our tips on year-end tax planning can be handy for you.
How to Trim Your Tax-Bill in 2021
- Defer Income Until Next Year – Consider the income you are due to receive in the rest of the year, and defer a part of it to next year. Some companies allow their employees to receive their bonus a month later for tax benefits. People who are self-employed or work as freelancers can delay sending out their invoices until late December 2021. That way, your clients won’t pay you until January. But make sure you think about the taxes for 2022 and defer the income accordingly.
- Direct Money into Your Retirement Account – Directing your money directly to your retirement savings gives you two advantages. Firstly, it reduces your taxable income that year. And secondly, the amount in your retirement account keeps compounding interest over time to increase your retirement savings.
The other option is to invest in a self-directed IRA where your money can grow tax-deferred. It is also a great way of reducing your taxable income for the year.
- Tax-loss Harvesting
If you have investments that have fallen below the purchase price, consider selling them at a loss to offset the capital gains in your taxable profits. The government allows you to use up to 3000 USD worth of losses to offset capital gains in your taxable income. If you incur a loss higher than 3000 USD, you can carry it over to the following year.
- Identify Possible Deductions
Itemize your deductions to avail better benefits compared to the standard deductions. When you itemize, you may realize that your qualifying expenses are greater than the standard deduction provided. Consider contributing to charities that offer tax benefits. You could also include your medical and dental fees for a tax deduction.
- Flexible Spending Accounts & Health Savings Account
Flexible spending plans allow you to save for child care or medical bills while providing relief from income and social security taxes. The catch is that you need to use these funds up by the end of the year. Health Saving Accounts also offer tax advantages while helping you pay for medical expenses. But you should have a high-deductible health insurance plan.
- Estimate Your Withholding
If you are struggling with a colossal tax bill this year, it may be because you did not withhold enough of your paycheck. Estimate the exact amount of income you need to withhold, and file a new W-4 form at your workplace. There are various free online withholding estimator tools available to help you calculate.
- Pay Your Bills Early
Consider prepaying deductible expenses for 2021 right now. Paying your bills for the next year beforehand is especially useful if you plan to itemize your deductions when you file your taxes. It includes payments like mortgage, state taxes due in January, and other deductible expenses.
- Roth Conversion
Tax advisors advocate Roth conversions with clients who have an unsteady income. It allows you to convert the funds in your pre-tax individual retirement account (401(k) to an after-tax Roth IRA). You will still owe levies on the converted money, but Roth IRA offers future tax-free growth. Roth conversions are considered apt in a year like 2021 when incomes have become unstable.
It is not possible to get the maximum tax benefit by focusing on only one tax-saving tactic. However, you could choose more than one move from the list above and find the best mix that suits your financial situation. If you’re unsure how to lower your tax bill this year, consider talking to a tax consultant or advisor.
Author Bio: Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He regularly writes for his own blog of Self Directed Retirement Plans and as a guest blogger to many sites in the niche of finance. If you need help and guidance with traditional or alternative investments, email him at [email protected] or visit www.sdretirementplans.com.