Dr. Nicholas E. Michels, CFP®
If you happen to be one of the many Americans entitled to a tax refund most years, you might consider yourself lucky. However, is getting a substantial refund really the best strategy? After all, those funds are earning interest for you while they sit around in absentia, waiting for your tax return filing to be doled out. Or maybe you like getting a big chunk back from the IRS and want to do more with it, but just don’t know where to start. In this guide, we’ll go over 10 tax-planning strategies to maximize your net worth.
Maximize Your Retirement Plan Contributions
One of the best ways to minimize your tax liability is to maximize your retirement plan contributions. Depending on your unique situation, you may be able to consider one or more of the following tax-advantaged accounts:
- 401(k), 403(b), and 457 Plans: These accounts allow you to contribute up to $22,500 in 2023 and $20,500 annually in 2022 ($27,000 if over age 50). Contributions are automatically deducted from your paycheck, meaning they 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. The 2022 contribution limit for traditional IRAs is $6,000 ($6,500 in 2023) with additional $1,000 catch-up contributions for individuals over the age of 50. Contributions 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, and the ability to pass wealth tax-free to your heirs. Unfortunately, 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): Self-employed persons and business owners with no employees can contribute up to $61,000 in 2022 and $66,000 in 2023 to a solo 401(k). Like other types of 401(k) plans, these contributions will reduce your current-year taxable income but would be taxed upon distribution in retirement.
Utilize Roth Conversions
If you are outside of the income eligibility threshold for Roth IRAs but still want to take advantage of the Roth tax benefits, a Roth conversion could be the right strategy for you. It works by paying the income tax on your IRA dollars and converting the funds to a Roth IRA. The optimal time to consider this strategy is after you retire but prior to taking Social Security or RMDs. It’s often best done over a series of years to maximize a tax bracket without being pushed into a higher one.
Another option is the mega backdoor Roth and backdoor Roth IRA strategies. With the mega backdoor Roth, you convert a portion of your 401(k) plan to Roth dollars. In this strategy, you would maximize your after-tax (non-Roth) contributions (up to $40,500 in 2022), then roll over this after-tax portion to the Roth 401(k) or your Roth IRA.
The backdoor Roth IRA strategy works by making an after-tax contribution to your traditional IRA and immediately converting the funds to a Roth IRA. This strategy is optimal if you don’t have an IRA set up yet.
All three Roth conversion strategies will allow the contributions to grow completely tax-free and allow you to avoid future RMDs, which is helpful if you expect to be in a higher tax bracket in the future.
Contribute to a Health Savings Account
Health savings accounts (HSA) offer triple tax savings. You can contribute pre-tax dollars, pay no taxes on earnings, and withdraw the money tax-free to pay for medical expenses. Unused funds roll over each year and can be withdrawn without penalty for non-medical expenses at age 65, essentially becoming an IRA. 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 earn tax-free growth. The 2023 IRS contribution limits for HSAs are $3,850 for individuals and $7,700 for families, up from $3,650 and $7,300, respectively, in 2022. 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.
Contribute to a Donor-Advised Fund
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 out of your donation tax-wise.
You can also donate appreciated stock, which can further maximize your tax savings. By donating the appreciated position, you avoid paying the capital gains tax that would have been due upon sale of the stock. If you want to keep the position for the long term and avoid the capital gains tax, you can donate the stock and then repurchase it using the cash you would have otherwise contributed. This effectively resets your cost basis to the current price of the stock and allows you to delay taxes until the future.
Make a Qualified Charitable Donation
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, and since this is an above-the-line deduction, it can be used in conjunction with other charitable tax strategies. A QCD is a distribution made from your retirement account directly to your charity of choice. It can also count toward your RMD when you turn age 72, but unlike RMDs, it won’t count toward your taxable income.
Harvest Capital Losses
Tax-loss harvesting involves selling investments at a loss in order to offset the gains in your portfolio. By realizing a capital loss, you are able to counterbalance the taxes owed on capital gains. The investments that are sold are usually replaced with similar securities in order to maintain the desired asset allocation and expected return.
For example, if you are expecting a large capital gain in the current year, you may want to harvest some of your losses by selling underperforming stocks to offset the gain. Keep in mind that you will need to wait 31 days before buying back the position in order to avoid the Wash-Sale Rule, which would disallow the loss. One risk with this strategy is that the stock could increase in price during the 31 days you don’t own it. To avoid this, consider investing in an index fund, like the S&P 500 ETF, in order to capture any market upsides during that time period. This can be a great way to make the most out of a losing situation by using an investment loss to offset the capital gains tax on your investment income.
Tax-loss harvesting can also be used to offset 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.
Take a Qualified Business Income Deduction
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 without limitation, consider reducing your income below the $170,050 phase-out threshold for individuals or $340,100 for married couples filing jointly. One way to do this is by maximizing your 401(k) and your spouse’s with any excess cash. If you are the sole employee in your business, you can also consider making a profit-sharing contribution to your retirement account.
Consider Estate Tax-Planning Techniques
Estate planning techniques can also be an effective way to reduce current-year tax liability. The gift and estate tax and exemptions have been increased to $12.06 million for individuals and $24.12 million for married filing jointly. The annual gift tax exclusion has also been increased to $16,000 per recipient, which allows a taxpayer to give this amount tax-free without using any of the previously mentioned lifetime exemptions. Not only that, but each taxpayer can give up to $16,000 per person to any number of people. By incorporating annual gifts into your overall tax strategy, you can significantly reduce both your taxable income and your taxable estate over time.
Understand 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. For instance, in 2022 a married taxpayer will pay 0% capital gains tax on their long-term capital gains if their taxable income falls below $83,350. That rate jumps to 15% and 20% for taxable incomes that exceed $83,350 and $517,200, respectively, and gains that are short-term in nature will be taxed at your marginal tax bracket, which could be up to 37%! Knowing both the nature of your gain, as well as your tax bracket, is crucial information if you want to minimize your tax liability.
Make Sure Your Advisory Team Is Working Together
Beyond consulting with a tax professional, you’ll want to be sure your entire financial team is working together to provide cohesive oversight and guidance. This should include professionals like CPAs, financial advisors, investment advisors, and estate attorneys. Your finances don’t exist in a bubble—and so neither will your tax-minimization strategies. When your advisory team works together, strategies are easier to identify and execute, and proactive tax solutions become much easier to implement, reducing stress and your tax bill.
Stop Overpaying Today
Tax planning doesn’t have to be stressful or complicated. At Michels Family Financial, we represent you, your life, your family, and your future. It’s not just financial planning; it’s your life. We want to help you make it great through our proven Complete Wealth Management process. Reach out today by emailing me at [email protected] to learn more about how we can help.
About Nick
As the founder, CERTIFIED FINANCIAL PLANNER™ professional, and National Social Security Advisor at Michels Family Financial, a financial firm founded on principles. Dr. Nicholas E. Michels spends his days helping clients find financial confidence, clarity, and results they desire. With 15 years of experience, Nick is passionate about helping others create a better life for themselves and their families, ensuring that their money is a blessing, not a stress-ridden curse. Nick prioritizes financial education, empowering his clients with the knowledge that will help them achieve financial security, peace, and happiness. Nick strives to build long-lasting relationships so he can design comprehensive financial plans that help them live out their dreams, using his proven Complete Wealth Management process.
As an accomplished basketball player, Nick became a two-time first-team All-American and Academic All-American basketball player at Dallas Baptist University and was DBU’s 2008 Male Athlete of the Year. This opened the door for him to spend many years traveling the world with Athletes in Action. Not only was this an amazing experience, but it also taught him a lot about pursuing something with passion and finding different ways to help and serve others. His athletic background helped lead him to this career because it gave him the confidence and ability to clarify needs and help his clients succeed.
Outside of work, you can find Nick staying active and spending time with his wife, Chelsea, and their three children, Daegen, Kinsley, and Nicholas Brooks. To learn more about Nick, connect with him on LinkedIn.