How to use all the available benefits to reduce your tax burden

Effective tax planning involves a combination of strategies to optimize in a legal way your taxes.

This encompasses understanding and utilizing tax-advantaged savings vehicles such as 401(k)s, IRAs, HSAs, and FSAs. Additionally, maximizing deductions through itemized expenses or taking advantage of the standard deduction is crucial. Tax credits, which directly reduce tax owed, offer significant savings potential.

By carefully considering these factors and potentially consulting with a tax professional, individuals can optimize their tax situation and retain a larger portion of their earnings.

In this blog, we will focus on which are the benefits available out there that most people do not know and could help you to reduce the tax burden and retain more of your money:

1. Use Tax-Advantaged Retirement Savings:

Tax-advantaged retirement accounts offer significant tax benefits. By contributing to these accounts, you can reduce your taxable income, lower your current tax bill, and potentially enjoy tax-free growth in the future. Strategic use of these accounts is crucial for building wealth while minimizing your overall tax burden.

• 401(k) Plan: A 401(k) is a retirement savings plan sponsored by an employer. It allows employees to contribute a portion of their pre-tax salary to an investment account.

• IRA: An IRA (Individual Retirement Account) is a retirement savings account that anyone with earned income can open.

How it lowers your tax burden:

• Tax deductions: Traditional IRAs and some 401(k) contributions can lower your current tax bill.

• Tax-deferred growth: Traditional IRAs and 401(k)s allow your investments to grow tax-deferred, meaning you won’t owe taxes on earnings until you withdraw the money in retirement. This can be beneficial if tax rates are lower in retirement.

2. Two accounts not often mentioned and can help: HSA & FSA

HSAs and FSAs offer tax advantages for healthcare expenses. HSAs allow pre-tax contributions, tax-free growth, and tax-free withdrawals for qualified medical costs. FSAs use pre-tax dollars to pay for eligible expenses, reducing taxable income. Both accounts can significantly lower your tax burden, especially if you have substantial medical costs.

Health Savings Account (HSA):

An HSA is a tax-advantaged savings account used to pay for qualified medical expenses. To be eligible for an HSA, you must be enrolled in a High Deductible Health Plan (HDHP).

How it lowers your tax burden:

• Contributions: You contribute pre-tax dollars to your HSA.

• Tax benefits: Contributions are tax-deductible, and the money grows tax-free.

• Withdrawals: Withdrawals for qualified medical expenses are tax-free.

Flexible Spending Account (FSA):

An FSA is a employer-sponsored benefit account that allows you to set aside pre-tax dollars to pay for eligible medical and dependent care expenses.

How it lowers your tax burden:

• Contributions: You contribute a specified amount of pre-tax money to your FSA.

• Tax benefits: Contributions reduce your taxable income.

• Withdrawals: You use the funds to pay for eligible expenses.

3. Choosing and Using the Right Tax Credits:

Tax credits offer a powerful way to reduce your tax bill. Unlike deductions, credits directly lower your tax liability, dollar for dollar. Claiming the right credits, such as the Child Tax Credit, Earned Income Tax Credit, or Education Credits, can significantly impact your refund or reduce the amount you owe.

• Child Tax Credit: This credit can significantly reduce your tax bill for each qualifying child. The amount of the credit depends on your income and the number of qualifying children.

• Child and Dependent Care Credit: This credit helps offset the cost of childcare for qualifying individuals. The credit percentage varies based on your adjusted gross income.

• American Opportunity Tax Credit: This credit can be used to offset the cost of tuition and fees for the first four years of post-secondary education.

• Lifetime Learning Credit: This credit can be used to offset the cost of qualified education expenses for yourself, your spouse, or dependent.

• Retirement Savings Contributions Credit: This credit is available to low-to-moderate-income taxpayers who contribute to eligible retirement plans.

• Earned Income Tax Credit: This refundable credit is available to low-to-moderate-income working individuals and families.

The amounts and eligibility for these credits can change from year to year. It’s crucial to consult the IRS website or a tax professional for the most up-to-date information.

4) Calculate and Possibly Use the Itemized Deductions

While the standard deduction offers a straightforward way to reduce taxes, itemizing deductions can provide greater savings for taxpayers with significant eligible expenses. It’s essential to calculate both options to determine which method is more advantageous for your specific financial situation.

• Standard Deduction: The standard deduction is a fixed amount that taxpayers can subtract from their adjusted gross income (AGI) to reduce their taxable income. It’s a simplified way to claim deductions.

• Itemized Deductions: Itemized deductions allow taxpayers to subtract specific expenses from their AGI. This option can be more beneficial if the total of these expenses exceeds the standard deduction.

How itemized deductions can reduce your tax burden:

• Dollar-for-dollar reduction: Unlike the standard deduction, itemized deductions directly reduce your taxable income by the exact amount of your eligible expenses.

• Potential for greater savings: If your itemized deductions add up to more than the standard deduction, you’ll save more money by itemizing.

Common itemized deductions include:

• State and local income taxes or sales taxes
• Real estate taxes
• Mortgage interest
• Charitable contributions
• Medical and dental expenses (above a certain percentage of AGI)
• Casualty and theft losses

Effective tax planning is essential for individuals and businesses to maximize their financial well-being. By strategically utilizing tools such as retirement accounts, health savings accounts, deductions, and credits, taxpayers can significantly reduce their tax burdens. While understanding these concepts is valuable, navigating the complexities of the tax code can be overwhelming.

A Certified Financial Planner (CFP®) with an hourly fee structure can provide invaluable guidance in developing a tailored tax plan. By assessing an individual’s financial situation, income, deductions, and goals, a CFP® can identify opportunities to optimize tax efficiency. Through expert knowledge and personalized advice, CFPs® can help clients make informed decisions, reduce tax liabilities, and achieve long-term financial success.

A comprehensive tax plan, crafted with the assistance of a CFP®, is an investment in financial security and peace of mind.

Alonso Rodriguez Segarra – CERTIFIED  FINANCIAL PLANNER™

Which provides hourly, fee-only, and fiduciary financial planning services. He has   over 20 years of experience in the financial world and has been named among the   Top 100 Financial Advisors in the US by Investopedia.

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Note: The comments given in this guide are for educational purposes only. Before    making a financial decision, consult your financial advisor or conduct appropriate      research. Remember that historical results are not a guarantee of future returns. In    the comments provided, this guide does not consider tax impacts. Always consult      your particular case with a specialist. We are not your financial advisor, so             remember that each case differs.

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All rights to this guide are reserved, and the occasional mention of third-party       brand names is made solely for educational and reference purposes, without any       interest in financial gain. This information is for educational purposes only and     does not represent an offer of products or services.