When you think of taxes, you probably don’t think of the word savings. But boosting your savings is something you can accomplish with the right tax-planning strategies.
Whether you need to increase your retirement savings or better fund a health savings account, these savings goals go hand-in-hand with tax planning. But have you already maxed out your contributions, or do you still have some room left to do so?
Understanding the limit increases for 2023 can help you manage your tax and savings strategies to get you where you need to be. So let’s dive right in and start with how to maximize your retirement contributions in 2023.
Maximizing Retirement Contributions
Maximizing your retirement contributions is one of the best ways to minimize your tax liability. This is because retirement plans offer useful tax advantages that are not available if you were to simply put your money in a savings account.
Since the new year just began, there are two main ways to maximize your contributions: (1) fully fund your 2022 accounts, most of which allow you to open or contribute up to the maximum through April 15th and still benefit the 2022 tax year, and (2) update your retirement contributions in 2023 to take advantage of the new, higher limits.
Here are some of the accounts to keep in mind when reviewing your contributions:
- 401(k), 403(b), and 457 Plans: These accounts allow you to contribute up to $20,500 annually for 2022 ($27,000 if over age 50). In 2023, these amounts have increased to $22,500 and $30,000 if over the age of 50. Not only that, but contributions done pre-tax won’t show up as part of your annual income. This is a great way to defer taxes until your retirement years when you could potentially be in a lower tax bracket.
- Traditional IRA: Contributing to a traditional IRA is another way to reduce your tax liability if your income is within certain limits. You can contribute up to $6,000 for 2022 and $6,500 in 2023. Both years have the same $1,000 catch-up contribution limit for those over age 50. Unlike the qualified retirement plans listed above, contributions to a traditional IRA can be made until the April 15th tax filing deadline.
- Roth IRA: This is an attractive savings vehicle for many reasons, including no required minimum distributions (RMDs), tax-free withdrawals after age 59½, as long as the account has been open for at least 5 years, and the ability to pass wealth tax-free to your heirs. The contribution limits are the same as traditional IRAs. However, Roth IRAs have income restrictions, and you may not be able to open an account outright if you are above certain limits.
- Solo 401(k), SIMPLE, & SEP IRAs: Small business owners still have time to open and fund these accounts for 2022. The 2022 and 2023 contribution limits for a solo 401(k) are the same as those for a traditional 401(k). SEP IRAs, on the other hand, allow employer contributions only and they must be no greater than 25% of compensation up to $61,000 for 2022, or up to $66,000 for 2023. SIMPLE IRAs are subject to employee deferral limits of $14,000 for 2022 and $15,500 for 2023. Employers are also required to either match employee deferrals up to 3%, or contribute 2% of compensation for all eligible employees.
Update Tax Withholding Elections
Just as the retirement contribution limits have increased due to inflation adjustments, the income tax brackets have too. This means that you can effectively earn higher amounts of income in 2023 before being pushed into higher tax brackets, as shown in the table below. Consider taking advantage by reducing your tax withholding elections and increasing your take-home pay.
Roth Conversions
If you are outside of the income eligibility threshold for Roth IRA contributions but still want to take advantage of Roth tax benefits, a Roth conversion could be the right strategy for you. It works by paying the income tax on your pre-tax traditional IRA and converting the funds to a Roth IRA.
You could also consider the mega backdoor Roth and backdoor Roth IRA strategies:
- Mega Backdoor Roth: If your employer plan allows it, this strategy allows you to convert a portion of your 401(k) plan to a Roth. This involves first maximizing the after-tax, non-Roth contributions ($40,500 for 2022 and $44,500 in 2023) in your plan. The next step is rolling it over to either a Roth 401(k) or, if your plan allows in-service distributions, even to your Roth IRA.
- Backdoor Roth IRA: In this case, you make an after-tax (non-deductible) contribution to a traditional IRA. You then immediately convert the funds to a Roth IRA to prevent any earnings from accumulating. Because of prorating rules the IRS imposes, this strategy makes the most sense if you don’t already have a large traditional IRA balance or roll that balance to your employer retirement plan before implementing.
All three Roth conversion strategies will allow the contributions to grow completely tax-free and allow you to avoid future RMDs. They are most helpful if you expect to be in a higher tax bracket in the future or will have large amounts of excess income from RMDs.
Health Savings Account Basics
An efficient but underutilized way to maximize your savings and minimize your taxes is to contribute to a health savings account (HSA). HSAs offer triple tax savings: contributions are tax-deductible, earnings grow tax-free, and you can withdraw the funds tax-free to pay for medical expenses. Unused funds roll over each year and can typically be invested in a variety of fund choices. You must be enrolled in a high-deductible health plan in order to qualify for an HSA.
HSAs can be a great tax-management tool if you are able to pay medical expenses out of pocket and leave the HSA funds to grow in your investment choices. The 2022 contribution limits for HSAs are $3,650 for individuals and $7,300 for families. In 2023, the contribution limits jumped to $3,850 for individuals and $7,750 for families. If you are 55 or older, you may also be able to make catch-up contributions of $1,000 per year. You have until April 15th for your contributions to count for the previous year’s tax return.
Advantages of Donor-Advised Funds
If you itemize your tax deductions because of charitable contributions, you may want to consider investing in a donor-advised fund (DAF). You can contribute a lump sum all at once and then distribute those funds to various charities over several years. With this strategy, you can itemize deductions when you make the initial contribution and then take the standard deduction in the following years, allowing you to make the most of your donation tax-wise.
You can also donate appreciated stock and funds, which can further maximize your tax savings. By donating appreciated securities, you avoid paying the capital gain tax that would have been due upon sale. This means you are effectively donating more to your charities of choice than if you had sold the stock yourself and donated the proceeds.
Qualified Charitable Donations
If you own a qualified retirement account and are at least 70½, you can use a qualified charitable distribution (QCD) to receive a tax benefit for your charitable giving. Since this is an above-the-line deduction, it can be used in conjunction with other charitable tax strategies too. A QCD is a distribution made from your retirement account directly to your charity of choice. It can also count toward satisfying your RMD when you turn age 73, but unlike RMDs, it won’t count toward your taxable income. Individuals can donate up to $100,000 in QCDs per year, which means a married couple can contribute a combined amount of $200,000!
Tax-Loss Harvesting
Tax-loss harvesting involves selling investments that have declined in value in non-qualified accounts in order to offset current or future gains in your portfolio or in other assets, like a rental home or business. The investments that are sold are usually replaced with similar securities in order to maintain the desired asset allocation and expected return. With the extreme market volatility of 2022, chances are you have some capital losses that can be utilized. For example, if you are expecting a large capital gain this year, sell an underperforming stock and harvest the losses to offset your gain.
Tax-loss harvesting can also be used to reduce your ordinary income tax liability if capital losses exceed capital gains. In this case, up to $3,000 can be deducted from your income, and capital losses in excess of this amount can be carried forward to later tax years.
Long-Term vs. Short-Term Capital Gains
Understanding the tax implications of long-term versus short-term capital gains can go a long way in reducing your tax liability. Gains that are short term in nature (held less than one year) will be taxed at your marginal income tax bracket, which could be up to 37%! Gains that are long term in nature (held at least one year or more) are taxed at more favorable capital gains tax rates.For instance, in 2023 a married taxpayer will pay 0% capital gains tax on their long-term capital gains if their taxable income falls below $89,250. That rate jumps to 15% and 20% for taxable incomes that exceed $89,250 and $553,850, respectively. Understanding where you fall on the tax table is an important part of minimizing your liability.
Knowing both the nature of your gain, as well as your tax bracket, is crucial information if you want to minimize your tax liability.
Qualified Business Income Deductions
If you meet certain IRS requirements, business owners involved in partnerships, S corporations, or sole proprietorships can take a qualified business income deduction (QBID) to help reduce taxable income and maximize tax savings. This allows for a maximum deduction of 20% of qualified business income, but limits apply if your taxable income exceeds a certain threshold. To qualify for this deduction, consider reducing or deferring income so that you can remain below the phase out threshold. A great way to do this is to maximize your retirement contributions to tax-advantaged accounts (as discussed in point #1).
Estate Tax-Planning Techniques
Estate tax-planning techniques can also be an effective way to reduce current-year tax liability. For 2022, the lifetime exemption for assets that can be given gift-tax free is $12.06 million for individuals and $24.12 for married couples; these amounts increase to $12.92 million and $25.84 million in 2023. For potentially high-value assets such as property or businesses, or even large investment portfolios, gifting to remove the asset from your estate may help reduce state or federal gift taxes. One tradeoff to note, however, is you may eliminate a potential step-up in costs basis at death for any asset you gift during your lifetime. In addition, there may be lookback provisions in certain circumstances.
In addition to the lifetime exemption, the annual gift tax exclusion has also been increased to $17,000 per recipient in 2023, up from $16,000 in 2022.This is the annual amount taxpayers can give tax-free without using any of the above-mentioned lifetime exemption. The annual exclusion applies on a per-person basis, so each taxpayer can give $16,000 ($17,000 in 2023) per person to any number of people per year. For example, a couple can give up to $160k to a family of five in 2022 (or $170k in 2023).
Though gifting and other estate tax-planning strategies are not tax-deductible, they can help to significantly reduce your taxable estate over time.
Start Preparing for Tax Season
Finally, it’s very important to start preparing for this tax season as soon as possible. Many of the documents required to file will be sent to you by employers, lenders, and investment brokers by January 31st. It can be easy to misplace these documents if you’re not keeping track of exactly what you need. Also keep in mind that the filing deadline is April 18th, 2023, due to the holiday in Washington, D.C., on April 17th. Though it may seem like you have time, you don’t want to wait until the last minute to get organized!
Who Do You Have on Your Team?
Wilkinson Wealth Management has a competent, professional team with a wide range of certifications, specialties, and industry experience. To learn more about tax-planning strategies that can help boost your savings, reach out today by calling 434-202-2521 or email susan.wilkinson@lpl.com to schedule an appointment.
About Bryan
Bryan Strickland is a financial advisor and CERTIFIED FINANCIAL PLANNER™ professional at Wilkinson Wealth Management, a financial services firm in Charlottesville, Virginia, providing customized financial planning and Investment strategies with a personal approach. Bryan uses his over 15 years of experience to help his clients navigate the complexities of their financial situation so they can look to the future with clarity and confidence. He strives to get to know his clients—what matters to them, their concerns, dreams, and goals—so that he can design a tailored plan to get them from point A to point B and walk with them through whatever life throws their way.
Bryan started his career as a project engineer and project manager after earning a degree in civil engineering from the University of Virginia. He made a career change to pursue his true passion of serving others through personal financial planning that puts the client first. Outside of work, Bryan loves spending time with his wife, Nicole, and their three children, Tyler, Izzy, and Brendan. You can also find him on the field as a volunteer coach for a local travel soccer team. He enjoys singing tenor with the Virginia consort and his church’s choir and participating in most sports, including soccer, triathlon, and obstacle course racing. To learn more about Bryan,connect with him on LinkedIn.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.