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Tax and retirement plan laws seem to be evolving at rapid pace over the last several years. The changes can seem confusing and difficult to keep up with so we thought it would be helpful to detail a few easy ways an individual and/or business can reduce their taxes.
Retirement Plan Contributions: An employer sponsored retirement plan (401k, 403b) remains one of the most effective way to save for retirement and lower taxes. Pre-tax contributions will lower one’s federal and state taxable income. For 2021, an individual can contribute up to $19,500 pre-tax to these plans; $26,000 for those over the age of 50.
If you are retiring with unused sick/vacation time, ask your Human Resources department if they would deposit those monies directly into your 401k/403b as a pre-tax contribution instead of cutting you a taxable lump sum check, especially if you do not need that money right away.
For those who are not covered by an employer sponsored plan, a Pre-Tax Individual Retirement Account (IRA) could be an excellent alternative. An individual can contribute $6,000 to a Pre-Tax IRA for 2021 and $7,000 for those over age 50. These contributions will also lower one’s federal and state taxable income.
Inherited IRA: Non-spouse beneficiaries (such as a child) of pre-tax retirement accounts (such as the accounts referenced above) will pay ordinary income taxes on any distributions from these accounts. Instead of taking a fully taxable distribution upon inheritance, a non-spouse beneficiary can open an inherited IRA and spread the tax liability out over a period of 10 years. If the beneficiary is no more than 10 years younger than the decedent, the beneficiary can stretch the distributions out over their lifetime.
Qualified Charitable Distributions (QCDs): If you cannot itemize your taxes (which few people can anymore) and are over the age of 70.5, you can send charitable contributions directly from a pre-tax retirement account to a qualified charity of your choice. This distribution is not taxable; thus, you can make a charitable donation with pre-tax dollars instead of after-tax dollars from a personal account. If you are already taking Required Minimum Distributions (RMDs) which must begin at age 72, you can direct a part of this distribution to a charity of your choice which will in turn lower your taxable income.
Roth IRA Conversions: A Roth IRA works the opposite of a Pre-tax IRA, taxes on contributions are paid at the onset, and the growth is tax free when withdrawn. Individuals in lower tax brackets (10-12%) could consider converting pre-tax retirement account monies to a Roth IRA, and lock-in paying lower tax rates.
For retirees who experience a drop in their income from their working days, annual Roth conversions allow them to control the tax bracket where their distributions are applied. For those who wait until age 72, the distribution amounts are set by the IRS and a person will have less control as to which tax bracket they fall into.
As an example, an individual age 72 in 2021, with a $1,000,000 pre-tax retirement account, would be required to distribute $39,062.50 and pay taxes on this amount. This could cause social security taxes to increase and even send a taxpayer into the IRMAA territory, (Medicare surcharge for those in higher tax brackets) if they have additional income such as a pension.
Small Business Retirement Plans: As a small business owner, you can choose one of several retirement plans to save pre-tax dollars and lower your taxable income. SEP IRAs can be ideal for solo business owners, where the owner can save up to 25% of their net income or W2 wages up to $58,000 for 2021.
A SIMPLE IRA can be ideal for a small business with a handful of employees, allowing for pre-tax contributions of up to $13,500 for 2021 ($16,500 for those over age 50) along with a 3% match. The match is available to the owner(s) and is tax deductible for the business.
A solo 401(k) can be utilized by a solo business owner and/or a business that only employs immediate family members. This plan allows for pre-tax contributions up to $58,000 for 2021.
Capital Gains Taxes: A couple that is married filing jointly will owe $0 on long term capital gains and dividends if their taxable income is $80,800 or lower in 2021 ($40,400 for single filers). Taxpayers that are holding onto long-term appreciated assets (held more than 1 year) and are under that threshold could consider realizing some of those gains while not having to pay the 15% capital gains tax.
Some other tax tidbits: Social Security is not taxable in New York. Additionally, the first $20,000 of private pension and/or pre-tax IRA distributions for those over age 59.5 are not state taxable.
While this is just a brief overview of simple ways to reduce your tax liability, we do hope you find this informative and helpful and encourage you to engage in further discussions with your tax and/or financial professionals.
Kane Financial, LLC is a registered investment adviser in the State of New York. Advisory services are only offered to clients or prospective clients where Kane Financial, LLC and its representatives are properly registered or exempt from registration.
This information is not intended as tax, accounting, or legal advice and is for informational purposes only. The information provided should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.