Question: How can we reduce our tax bill for this year? We’re open to contributing more to our 401(k) and HSA, but also want to keep enough cash available to buy a home in the next year or so.
This is a question that often comes up for people as we get closer to the end of the year.
When creating a plan for managing taxes, you want to understand your total income for the year. Is your income just from a base salary? Or are there other sources such as bonuses, commissions, dividends, equity compensation, etc.
From there we recommend starting with pre-tax savings - employer sponsored retirement plans, Health Savings Accounts (HSA), and other pre-tax benefits.
Employer sponsored retirement plans
Many companies offer access to both Traditional and Roth 401(k) or 403(b) plans. By making pre-tax contributions to your Traditional 401(k) or 403(b) you are reducing your taxes in the year the contributions are made as well as deferring taxes on the investments as they grow (i.e. income tax on quarterly dividends). If you are able, we recommend maxing out contributions, which is $20,500 for 2022.
Health Savings Accounts
Consider utilizing an HSA, if available. These types of accounts are another way to reduce current taxable income and enjoy future tax benefits. The maximum contribution to an HSA for 2022 is $3,650 for an individual and $7,300 for families.
Other Pre-Tax Benefits
Review other employee pre-tax benefits such as commuter passes, supplemental life insurance, etc.
Once you’ve taken advantage of all pre-tax savings, we recommend that you also review whether or not you have investment gains or losses, and what deductions you'll be able to claim on your income tax return. Some of those deductions include charitable contributions, mortgage interest, and property taxes. Your itemized deductions will need to be higher than the standard deduction ($12,950 for an individual and $25,900 for joint filers for the 2022 tax year) to have the greatest benefit.
Something to note about the question above is that they don’t want to reduce their tax burden simply for the sake of paying lower taxes. They’re willing to defer taxes through a retirement plan up to a point because they’re keeping their primary goal in mind, which is to purchase a home soon. Knowing what the savings goal is, i.e. how much you’ll need for the down payment, is important when strategizing how to lower your taxes.
If you have a goal that will require a lot of cash in a short period of time, contributing to a retirement account that can’t be accessed until age 59 ½ (without penalty) may not be the prudent thing to do. In this situation, having more of your income available to put towards the down payment makes the most sense in the short-term.
Ultimately, managing your taxes should be part of creating your overall financial plan, not the primary goal. There is a balance between reducing your tax liability and pursuing goals such as home ownership. We recommend that you work with a Certified Public Accountant (CPA) for tax advice specific to your financial situation.
Range is here to help.
With Range, you can set goals, like buying a home, and work with our team of Certified Financial Planners to come up with a tax efficient plan to help your dream become reality.