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Financial Learning Center


Understanding the Basics

Simple Tax-Advantaged Planning Strategies To Consider

Besides cutting expenses and controlling spending, there are two things you can do to increase your cash flow: earn more money or keep more of what you earn. You may be able to increase your take home pay by following some simple tax planning strategies.

Adjust your income tax withholding: Do you get a big refund every year when you file your tax return? While you may be viewing this as a forced way to save, you are, in fact, giving Uncle Sam an interest-free loan. You're deferring current income and foregoing the interest. Obtain a Form W-4 from your employer. Follow the instructions to arrive at your new withholding allowances. Take the extra money from your paycheck and earmark it for a particular financial objective. If you can put it towards retirement, increase your retirement plan contribution.

Your company retirement plan vs. an IRA: The decisions you make regarding which vehicle(s) to use to save for retirement are complicated. Before the introduction of the Roth IRA, it was usually best to put the maximum pre-tax contribution into a company savings plan to take advantage of tax-deferred growth. With the Roth IRA, individuals that are eligible to establish one can take advantage of tax-free growth and tax-free withdrawals in retirement. To help you make decisions that fit your specific situation, have a look at the following options:

Consider making the maximum pre-tax contribution to your company retirement plan, especially if it has a company match. Payroll deduction ensures the money will go into your account. In addition to the maximum pre-tax contribution, special catch-up contributions can be made annually to certain plans if you are at least age 50.

If you are a low- to middle income taxpayer, you may be eligible for a tax credit for contributions you make to certain retirement plans including IRAs. This tax credit is in addition to the tax benefit you get from making pre-tax contributions to a retirement plan.

A company retirement plan will typically allow you to make a much higher annual contribution than an IRA.

If you've maxed out the pre-tax annual contribution to your company retirement plan, and you qualify to establish a Roth IRA, save in the Roth IRA to take advantage of tax-free growth and withdrawals. If you don't qualify for a Roth IRA because of the income limit, you can make a non-deductible contribution to a traditional IRA. In addition to regular IRA contributions, special catch-up contributions can be made annually to both traditional and Roth IRAs if you are at least age 50. See the section Individual Retirement Accounts for a more detailed discussion of IRAs.

Flexible Spending Accounts: Your employer may offer you a flexible benefits program. This allows you to pay for certain expenses with pre-tax dollars.

For example, you may have certain out-of-pocket medical costs, such as deductibles and coinsurance. You may also be anticipating orthodontia or vision care expenses that are not covered by insurance. If you have children, you may have expenses related to childcare, day camps, and nursery schools. These kinds of expenses can typically be paid for with a reimbursement account.

Suppose you estimate your minimum out-of-pocket medical expenses this year will be $500. You should elect to have $500 put into your health care flexible spending account. If you paid these expenses directly, you would have had to earn $667 assuming you're in a 25% tax bracket. That's $167 more for you to save or spend.

IMPORTANT NOTE: How much you put into the account is usually only an estimate. Carefully determine how much to put in because if you don't use all the money in the account by the end of the plan year, you will lose it. That is a real catch, so it pays to estimate carefully. If you feel comfortable estimating your additional out-of-pocket medical and dependent care expenses, you should arrange to begin contributing or increasing your contributions to a flexible spending account.

Owning your own home vs. renting: You get a tax deduction for your mortgage interest and property taxes. Besides the potential equity appreciation, you gain from home ownership, the long-term tax benefits associated with home ownership could make renting a poor substitute.

Shifting income among family members: You may have considerable savings earmarked for a particular financial objective. You may have other members of your family, like a child or dependent parent, who are in a lower tax bracket than you. If you choose, you can transfer your unearned or "investment" income to a family member in a lower tax bracket. These techniques may be used in funding your child's education or providing parental support. It may require setting up certain kinds of trusts and/or a schedule of annual gifting.

IMPORTANT NOTE: Do not use this tax strategy if you believe your child will be eligible for financial aid. The governmental formula to determine financial aid uses a greater percentage of the child's assets in determining your expected family contribution.

Accelerate deductions and defer income: Know your tax bracket. If you have sources of income other than what you earn, you may want to discuss with your tax professional how to minimize your taxes for the current year, and subsequent years. Should you take more income this year or next? This may require some sophisticated planning that requires you to have extensive knowledge of tax law as well as any legislation being proposed in Congress. Your tax professional can advise you on strategies that will help you determine when it is best to defer current income and accelerate personal and business deductions or vice-versa.

Deducting your medical expenses: It is often beneficial to keep track of your out-of-pocket medical expenses for the year. For example, did you know that medical premiums you pay for with after-tax dollars may be tax-deductible? However, medical premiums you may pay as an employee may be paid on a pre-tax basis, in which case they are not deductible on your tax return. Capital expenditures for home improvements for medical reasons may qualify, as well as nursing home costs and special care facilities, and transportation, meals, and lodging expenses while obtaining medical care. If you have expenses related to your medical condition, or your spouse's or dependent's, make sure you keep track of them and discuss them with a tax professional. Even if you don't have enough expenses to deduct on your federal tax return, you may be able to deduct them for state tax purposes.

Charitable Deductions: You may be able to take valuable deductions on your tax return by cleaning out your attic and making charitable contributions. You are required to substantiate the amount of cash and non-cash contributions you make during the year. The extent of information you must keep depends on the amount of your contributions and whether they are cash or non-cash. Consult your tax professional for help regarding substantiation requirements for charitable contributions.

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