You know you have to pay them, and that they help your neighborhood and the country as well. But it’s hard to see such a large chunk of your money come out every month when you need it for paying bills and saving for your financial goals.
But that doesn’t mean that you have to pay out an arm and a leg. If you follow the government guidelines, you can lower your taxable income and decrease your tax bite legally while still contributing your fair share to the
1. Save more in your 401k
If your employer has a qualified traditional 401k plan, then you are able to lower your taxable income while securing your financial future and retirement. You are allowed to contribute up to $19,000 each year ( or $25,000 if you are over 50) before federal, state, and local taxes are withdrawn.
These plans save you on taxes today because contributions are taken out of your income BEFORE taxes are taken out, as
Let’s assume your salary is $50,000 and your tax bracket is 20 percent. Without making a contribution, your taxable income is $50,000 and taxes owed is $10,409. Now if you contributed the maximum allowed contribution of $19,000, you lowered your taxable income to $31,000 and owe just $7099. Saving you $3,310 in taxes.
So not only do you get savings for retirement, you save on taxes today too.
2. Contribute to your Health Savings Account
If you have a high deductible insurance plan health insurance plan then you have access to a health savings account (HSA). Contributions made to HSAs are deducted before taxes and just as the traditional 401k, can lower your taxable income.
Not too shabby.
So with our previous example, if you saved $3500 to an HSA, you would lower your taxes by $623. Not too shabby. Unfortunately, if you live in New Jersey or Calfornia then this tax-exempt contribution may not apply to you – check with your insurance provider to confirm.
3. Fund your FSA
If you have access to a flexible savings account(FSA) with your employer – whether for medical &dental expenses, or dependent care expenses – then you
Funds are subtracted from your income before taxes, and you can request reimbursement for the funds saving you hundreds of dollars each year.
But be careful. FSA funds must be used up by the end of the year or it will be forfeited i.e. use it or lose it. So never save more in an FSA than you are certain you will use up in a year.
4. Start an IRA
A traditional Individual Retirement Account (IRA) allows employees to save for their retirement on their own. If you are single and have a modified adjusted gross income (MAGI) of under $74,000 or are married filing jointly and have a MAGI of under $123,000, then you are eligible for a deduction up to your IRA contribution.
That means a lower taxable income and paying less in taxes.
With our example of earning $50,000 in a 20% tax bracket, if you also contributed the maximum IRA contribution of $5500, you’d lower your taxable income by $5500 and lower your
And if you were able to contribute to multiple goals, say the maximum 401k and IRA contribution then you’d save even more. In fact, you’d reduce your taxable income by $24,500. And your tax due would be $6148, nearly 50% less than if you made no contributions at all.
5. Put some money in your kids 529
Not all states have this as an option but if you live in one of the following states (green or dark gray), then making a contribution to your child’s 529 allows you access to a reduction on your state and local taxes not your federal taxes.
A working example – How to make six figures and pay no taxes
Let’s take a couple. Kim and Larry. Kim works as a science teacher in her local high school making $45,000 and Larry is a network administrator at a local grocery chain making $65,000. Together, they earn $110,000.
Right now, they have their eyes set on financial freedom and securing their retirement so they reduce their living expenses and are all about paying as little tax as possible. So they dedicate Kim’s paycheck to savings and live on Larry’s check alone.
Kim’s school offers a 401k plan and since she works for the government, she also gets access to a 457 (the government version of a 401k). So Kim makes contributes the full $19,000 per year to her 401k, and also contributes the full $19,000 to her 457 – something she can legally do.
Larry also contributes the maximum $19,000 2019 limit allowed.
Since they want to take advantage of every opportunity to reduce their taxes, they both contribute to traditional IRAs, with $6000 per year each (a total of $12,000.
And being on Larry’s high deductible health care plan, he contributes $7000 in savings to their HSA.
At the end of the day, out of the $110,000 dual-income, Kim and Larry have tax-deferred $76,000 of their income and now only have $34,000 of taxable income.
With the current standard deduction of $24,000 for joint filers, then the remaining amount for taxes is just $10,000. This puts them in the lowest 10% tax bracket having a tax bill of $1000.00.
Since Kim and Larry’s AGI is under $38,500, they qualify for the Saver’s Credit formerly known as the retirement savings contribution credit. They will receive 50% of the first $4000 retirement
That totally covers the couple’s tax liability and offers then a $1000 return. Not too shabby.
Lowering your taxable income isn’t a loophole.
It’s not gaming the system or avoiding to pay your fair share.
The government wants to save for your retirement, set aside funds for your health, take higher deductible insurance plans to lower medical costs, and even help you afford daycare a little easier. And they know the best way is to offer incentives for you to take those actions.
So they make these credits/deductions available to incentivize you to do what they want you. By taking advantage of these, you are helping the government achieve
And the best part is, many of these activities can be coupled together lowering your income even further. It’s a win-win.
So help the government (and yourself) out already and get some of these done!