What is tax planning really?

There are a lot of misconceptions floating around about what tax planning is and what it isn’t. First, let’s define what it isn’t. Tax planning is not a magical solution to pay nothing in taxes and may not even significantly reduce the amount of taxes you pay. It is not shady and unethical, and it is not only available to the rich or high-income earners. Good tax planning optimizes your current financial life by making (typically small and moderate) changes to save on taxes.

Contributing to a Roth IRA is good tax planning. Contributing to an HSA is good tax planning. Making sure you take all deductions and credits you are eligible for is good tax planning. While tax planning is available to anyone, regardless of income, there are some strategies that are available more broadly and others that may only apply in more specific situations.

Tax planning for all

There are some tax planning strategies that are more accessible than others. You don’t need a high income, a large investment portfolio, or a complicated tax situation to take advantage of these strategies.

Contributing to retirement accounts

Making contributions to tax-advantaged retirement accounts is one of the best tax planning strategies out there. If you aren’t sure exactly which account to contribute to first, check out our Financial Order of Operations. Consider maximizing any employer match first, then maximizing your Roth IRA and HSA, and next maximizing your employer-sponsored account if you are able to. The following table shows the maximum amount that can be contributed to these tax-advantaged accounts.

All of the above accounts have tax advantages, but some work differently than others. Roth IRAs have no tax deduction at the time your contribution is made, but all contributions grow tax-free and qualified distributions are tax-free, which is an incredible benefit. HSAs do offer a tax break on contributions, and also grow tax-free and offer tax-free distributions, just like Roth IRAs. The “catch” is distributions are only qualified (and tax-free) when used for eligible medical expenses. Roth employer-sponsored plans, such as Roth 401(k), work very similarly to Roth IRAs. Pre-tax employer sponsored plans offer a tax break on contributions, but qualified distributions count as taxable income.

Tax deductions and credits

What are called “above-the-line” tax deductions and credits are available even if you don’t itemize, but are often narrow in scope. You might need to have paid student loan interest, or have children and make under a certain amount, or contribute to a retirement plan and have a low income. Most tax software and tax professionals are pretty good at recognizing tax deductions and credits you may qualify for, but it’s always worth double checking just to be sure. Check out our list of some of the lesser known tax deductions and credits.

Tax planning for some

Some more “advanced” tax planning may only be relevant to you if you have a higher income, large investment accounts, own a business, or have a more complicated tax situation. Being more advanced, these strategies may not always be easy to do yourself. If you are ever in doubt, consult a trusted tax professional and/or a fee-only financial advisor.

Business ownership

Owning your own business can have some great tax advantages. When you think of “owning a business,” you might imagine a wealthy store owner, but owning and operating your own business has never been more accessible. Do you drive for Uber Eats? You own your own business. Do you sell handmade goods on Etsy and at craft fairs? You own your own business. One of the biggest tax advantages of business ownership is that money you invest back in your business saves you money on taxes. If you have an extra surplus of cash one year, it might be a good year for major business purchases.

Itemizing deductions

Close to 90% of Americans take the standard deduction, as most Americans wouldn’t have enough itemized deductions for it to make sense. However, if you have a larger number of itemized deductions, there is tax planning you can do to maximize your tax breaks. One common example is with charitable contributions. If you are on the border of itemizing and taking the standard deduction and make generous contributions to charity, bunching charitable contributions could be a strategy worth considering. Here’s an example:

Joanne contributes $10,000 per year to her favorite charity. She takes the standard deduction on her taxes each year. Her financial advisor suggests she “bunch” charitable contributions and instead contribute $30,000 to her favorite charity every three years. By doing this, Joanne can itemize on her taxes once every three years and use her charitable contributions to lower her tax burden.

Capital gains avoidance and tax-loss harvesting

If you have a large amount of money invested in a taxable brokerage account, realized capital gains could be a big issue for you come tax time. However, there are strategies that may be worth implementing to reduce your tax burden. In some cases, it could make sense to sell an investment fund before capital gains are distributed to avoid taxation. If some of your investments have losses, it could make sense selling those at a loss to offset gains. Capital gains avoidance and tax-loss harvesting can be complicated, so if you ever have questions feel free to reach out to us at Abound Wealth.

Tax planning isn’t some shady area of financial planning that can drastically reduce your tax burden. Good tax planning is about optimizing your finances to keep more money in your pocket and in your retirement accounts. If there’s one thing the vast majority of Americans can agree on, it’s that paying a little less on our own taxes wouldn’t be a bad thing.

Changes to retirement accounts

Most retirement account limits are increasing in 2024, and many are increasing greater than the current inflation rate. 401(k) limits also apply to 403(b) plans, most 457 plans, and TSPs.

401(k) limits went up 9.8% last year, more than IRAs and HSAs, so I guess the IRS felt like they needed to pump the brakes a little bit there. IRA limits went up again, but unfortunately $7,000 is not easily divisible by 12 for everyone contributing monthly. Like last year, I will once again be the old man on the front porch yelling about IRA limits. When IRAs were created in 1974, the contribution limit was $1,500. If it had been indexed to inflation since the very beginning, the limit would be over $9,000 today. I think we could take it one step further and increase IRA limits to match 401(k) limits. Not all jobs offer 401(k)s or equivalent retirement plans, and the $7,000 limit runs out very quickly for those who are serious about saving for retirement.

For a 30-year-old who has access to an HSA, Roth IRA, and 401(k), they can contribute a total of $34,150 to tax-advantaged retirement accounts. That means a single person would need an income of $136,600 to complete step 6 of the FOO without investing more than 25% of their gross income. Having a high income is not the only way you can complete step 6. As long as you are investing 25% for retirement, and know you are saving what you should be, you can move on to step 7 of the Financial Order of Operations.

Account limits aren’t the only thing going up next year; income phaseouts will also be increasing. For most, that just means you may have a little more time before you have to worry about using the backdoor Roth strategy. For the table below, “401(k)” is used as a proxy for all qualified workplace retirement plans.

Standard deduction and marginal tax rates

Standard deductions are raised yearly, and most taxpayers take the advantage of the standard deduction. However, this year we could see a rise in Americans not taking the standard deduction. Mortgage interest is an itemized deduction, and with 30-year mortgage rates currently over 7%, more Americans may now want to see if itemizing could be better for them. It doesn’t take an enormous mortgage for itemizing to start making sense, either: someone with a $400,000 mortgage at today’s rates (7.32% for a 30-year) would pay $26,735 in interest in the first full year of owning their home. Here’s what the standard deduction is this year and what it will look like next year.

Marginal tax rates will once again remain the same next year, but income thresholds will increase for inflation. The table below shows single tax rates this year and next year.

The next table shows marginal tax rate thresholds for married couples this year and next year.

Other IRS tax changes in 2024

Changes to retirement accounts, standard deductions, and marginal tax rates are just scratching the surface of all the IRS changes this year. Check out the IRS rundown of changes going into 2024 for other notable changes and notable items that aren’t changing. One always notable change worth mentioning is the Social Security Cost of Living Adjustment, or COLA, which is 3.2% for 2024.

We update our Money Guy Tax Guide every single year as you are heading into tax season. The current version covers all the numbers you need to know as you file taxes in 2024. This PDF is 12 pages full of tables, numbers, Money Guy tips, and more. If you find it useful, please consider sharing the resource with a friend or family member.

Note: all information provided below is for tax year 2023, where possible.

1. Student loan interest deduction

Qualified student loan interest you paid throughout the year is an above-the-line deduction – which means you don’t need to itemize to claim it. There are some stipulations, though. The income phaseout for the deduction starts at $75,000 MAGI (modified adjusted gross income) for single filers, and completely phases out at $90,000. For married filers, the phaseout ranges from $150,000 to $180,000. The deduction is only available for student loan interest, not the total amount paid towards student loans.

The parameters for qualifying student loans are fairly broad, and unlike some other government programs, private student loans qualify the same as public, government student loans.

2. Saver’s credit

Did you know you may be able to qualify for a tax credit just for saving for retirement? The saver’s credit is worth up to $1,000 for single filers or $2,000 for married filers. To be eligible, you have to be 18 or older, not a full-time student, and not a dependent on someone else’s return. The income limits do exclude many middle and high-income families. Your AGI must be under $36,500 (single) or $73,000 (married) in 2023 to qualify for the credit. Depending on your AGI, you may be able to take a credit for 10%, 20%, or 50% of the value of your retirement account contribution (limited to $1,000/single or $2,000/married).

Contributions to traditional and Roth IRAs, 401(k)s, 403(b)s, 457(b)s, and more qualify. It’s important to note that this is a credit, not a deduction, which means it reduces your tax liability dollar-for-dollar.

3. Charitable deductions

Most folks know that charitable contributions are deductible, but they don’t know how to optimize their charitable giving tax deductions. You must itemize your deductions to claim charitable contributions, which means for most Americans, it may not make sense to claim charitable contributions on their taxes. However, if you give significantly to charity each year but still take the standard deduction, it may be worth lumping your contributions into one year and itemizing that year.

Here’s what I mean: if Tom and Patti give $25,000 to a qualified charitable organization each year, it may still be better for them to take the standard married filing jointly deduction of $27,700. But if they only give $50,000 every other year – still giving the same amount over time – they could itemize and deduct those contributions, potentially up to 60% of AGI.

Giving to charitable causes doesn’t open up any secret tax loopholes where you end up making more money by giving, but for those who are naturally generous, it is certainly nice to get a little back on your taxes. Studies have shown that generosity has a positive effect on happiness. Even if you won’t ever itemize charitable contributions, giving can still have a positive impact on you and your community.

4. Child tax credit

The expanded child tax credit no longer exists, but the OG child tax credit is still around. In 2023, the credit is worth up to $2,000 per qualifying child, and up to $1,500 of that credit is refundable. Only children under 17 qualify, and you can only claim the full credit if your MAGI (modified adjusted gross income) is under $200,000/single or $400,000/married (income phaseouts start at those thresholds).

5. Child and dependent care credit

It’s easy to get the child tax credit and child and dependent care credit confused. The child and dependent care tax credit is for reimbursing parents for childcare while they work. Only parents with children 12 and under can qualify (unless your spouse or other person(s) claimed on your tax return require paid care). You and your spouse (if married) must have earned income to qualify, and you must have paid for care so you could work or look for work.

The amount of qualified expenses is $3,000 for one person or $6,000 for two or more. Depending on your income, you can claim 20% to 35% of those qualified expenses as a tax credit. The credit does not phase out for high-income earners, but the percentage of expenses they can take as a credit is reduced.

6. Mortgage interest deduction

Great news for everyone who is buying a home at interest rates over 6%: you may be able to deduct your mortgage interest paid. This is an itemized deduction, so it may not make sense to take if you don’t have other itemized deductions or if the standard deduction will end up being more beneficial. On homes purchased before December 16th, 2017, you can deduct interest on loans up to $1 million; if you purchased on or after that date, the current limit is $750,000.

If the mortgage interest deduction alone doesn’t make it worth itemizing, you may be able to combine other itemized deductions, like charitable contributions, to make it worth your while. Many homebuyers today are paying more in interest on their home loans, which may be deductible if they itemize.

There is no secret to paying less in taxes, but planning your tax year in advance can help you maximize opportunities throughout the year so you aren’t scrambling each year at tax time. For planning throughout the year, I have enjoyed using the Taxes App which helps you determine if you are on-track to pay the right amount in taxes. Nobody likes getting a surprise tax bill in April, and getting a hefty refund isn’t optimal for Financial Mutants. Check out our Money Guy Tax Guide for information on other credits, deductions, tax rates, and more.

Rebalancing your portfolio can lead to some tax advantages. In this highlight, Bo and Brian discuss some of the ways rebalancing can help from a tax standpoint.

If you haven’t already, check out our free resources to make the most out of your money!