January 13, 2021
It might seem entirely too early to start thinking about your 2021 taxes. After all, it’s still early January and the tax deadline for 2020 taxes is approximately four months away. However, it’s a good idea to think of tax planning as a year-round process, not just something you do at the end of the year and before your tax return is due.
With that in mind, here are six tips to help you think about how you can save thousands of dollars on your taxes this year and next.
1. Max out your retirement accounts
Do you have a 401(k) plan or other employer-sponsored retirement plan at your job? If so, you were allowed to set aside as much as $19,500 of your compensation in the account last year ($26,000 if you’re 50 or older), and while the IRS hasn’t yet announced it, the 2021 contribution limit is likely to be even higher.
Not only can increasing your 401(k) contributions help lower your 2021 tax bill dramatically, but you’ll be setting yourself up for a more secure retirement in the process.
2. Save for college
If you have children — even if they’re very young — it’s never too early to start setting aside money for their education. In fact, because of the long-term compounding power of investing, starting early can make it much easier.
A 529 savings plan is a type of investment account designed to help parents invest for college in a tax-advantaged manner. While you won’t receive a federal tax deduction for your contributions, many states offer a state tax deduction for money you deposit into an account. And no matter how much your investments grow, any qualified withdrawals to pay for education expenses will be 100% tax-free.
3. If you have an HSA, use it as much as possible
If you are enrolled in a high-deductible health insurance plan, you’re eligible to contribute to a health savings account, or HSA. For 2021, this is defined as a plan with a deductible of at least $1,400 for individual coverage or $2,800 for family coverage.
If you qualify, you can contribute as much as $3,600 to your HSA in 2021 if you have single coverage or as much as $7,200 if you’re enrolled in a family health plan.
An HSA is perhaps the most tax-advantaged account of all. Contributions are deductible, so if you contribute the $7,200 max for 2021, it will be completely deducted from your taxable income for the year. Once in the account, money can be invested — similar to a 401(k). And withdrawals to pay qualified healthcare expenses will be 100% tax-free, providing a rare double-tax advantage. If you don’t end up needing the money to pay for healthcare, you can simply leave it in your HSA until retirement — after 65, you can withdraw money from an HSA for any reason.
4. Contribute to (or open) an IRA
If you set aside money in a traditional or Roth IRA and invest in virtually any stocks, mutual funds, or exchange-traded funds (ETFs) you want. Hopefully in 2020, you contributed as much as $6,000 to your IRA ($7,000 if 50 or older), and this will either be the same or higher in 2021. If you qualify, you might be able to deduct traditional IRA contributions on your tax return, and while Roth IRA contributions aren’t deductible, eventual withdrawals can be completely tax-free.
It’s also worth mentioning that you can make IRA contributions until the tax deadline, so you can contribute for the 2020 tax year until April 15, 2021, and for the 2021 tax year until Tax Day in 2022.
5. Go green
If you own your home and install alternative energy equipment such as solar panels, wind turbines, or solar hot water heaters, you can claim a tax credit based on your out-of-pocket cost. The value of this credit is dropping, but it is still worth 22% of your spending in 2021, so $2,200 for every $10,000 of qualified spending. And this is one you might want to take advantage of before the end of 2021 — starting in 2022, the credit disappears for residential solar energy systems.
6. Add up your healthcare costs
Healthcare expenses are only deductible to the extent they exceed 7.5% of your adjusted gross income (AGI), but in the modern age of high healthcare costs and high-deductible health plans, you might be surprised how much you’re actually spending on healthcare. If you make $100,000 in 2021, for example, this means that any healthcare spending in excess of $7,500 can be deductible. And in addition to the obvious expenses, don’t forget to consider things like dental care, prescription eyeglasses, and even the mileage to and from medical appointments.
A year-round activity
As we mentioned earlier, tax planning should be a year-round activity, and by gradually making tax-friendly financial decisions like saving for retirement, college, and healthcare throughout the year, you could quite easily reduce your 2021 tax bill by thousands of dollars.
LMC is here to help
Need help planning your taxes or have a specific tax question for this tax season? Louis Mamo & Company has the personnel in place to help you with all of your personal and business tax needs. Please contact us today to discuss your specific tax situation and allow us to provide the solutions you need.
(Sources: The Motley Fool, Fox Business News and the Internal Revenue Service).