With the start of the new year, tax documents are beginning to trickle in. Some of you may be surprised by the amount of capital gains realized in 2016 due to the sale of assets or through capital gains distributed by mutual funds.
While you can’t undo what occurred in 2016, here are a few ideas to help reduce your taxable income for 2017:
??? –? Contribute to your company-sponsored retirement plan. Many workplaces will let you invest pre-tax dollars into the company-sponsored retirement plan. If your company’s plan is a 401(k), 403(b) or 457(b) plan, every dollar you contribute, up to $18,000 for 2017, reduces your taxable income by the contribution amount. If you are 50 years of age or older, you are allowed an additional $6,000 in catch-up contributions, providing a potential of $24,000 of pre-tax contributions into the retirement plan. As an added bonus, many companies will match a portion of your contributions. Every plan is different, so check with your plan administrator to find out what benefits your company provides. Keep in mind that taxes will be owed on any distribution of pre-tax contributions and earnings for this type of tax-deferred account. If you pull money out before age 59 A1/2, then you could be facing an early-withdrawal penalty as well. If you leave the company sponsoring the plan between ages 55 and 59 A1/2, generally you can take distributions from the plan without the early-withdrawal penalty. However, you would have to pay income taxes on it.
–? Contribute to an Individual Retirement Account (IRA). Depending on your income, tax-filing status and your ability to contribute to a company-sponsored plan, you may be able to contribute to an IRA. Many people enjoy the investment flexibility that an IRA allows, because the IRA is not limited to the investment options the company-sponsored plan offers. By contributing to an IRA, you are again lowering your taxable income by contributing pre-tax dollars, up to $5,500 for 2017 plus another $1,000 catch-up provision for anyone 50 or older. If you are married, you may be able to reduce your taxable income even more by contributing to an IRA for your spouse also. Remember, taxes will be owed on any distributions from the IRA, and a 10% early-withdrawal penalty may apply if you take a distribution before you turn 59 A1/2. There are a few exceptions to the early-withdrawal penalty.
–? Purchase a tax-deferred annuity. If you have maximized your contributions to your company-sponsored plan and/or your IRA but still wish to save additional funds for retirement, you may want to consider a tax-deferred annuity. This type of investment is purchased with after-tax dollars, so you cannot deduct the purchase amount from your taxes. However, since all the earnings and growth of the investments stay inside of the annuity, you would not receive 1099 forms for dividends and interest earned on an annual basis. Taxes will be owed when withdrawals are made, but only on the growth of the investments. If you withdraw from the annuity before you reach age 59 A1/2, then a penalty may apply. Insurance companies issue these types of investment vehicles in different forms. Their features, costs and strategies vary greatly, and they can be complicated. So make sure you understand what the product does or does not do before you buy.
??? –? Contribute to a Health Savings Account (HSA). If you are enrolled in a high-deductible health plan — one with a deductible of $1,300 or more for an individual, or $2,600 for a family — you can make contributions to an HSA and receive a tax deduction. For calendar year 2017, an individual will be able to deduct $3,400 of contributions, while a family will be able to deduct $6,750. A $1,000 catch-up provision applies to those 55 or older. Contributions can be invested in a variety of investment vehicles, and the interest or earnings are not taxed. Distributions from the HSA may be tax-free if they are used to pay for qualified medical expenses. The HSA is also portable, meaning that it stays with you if you were to change jobs or decide to retire. Some people choose to pay their deductibles and co-pays out-of-pocket during their working careers. They contribute to their HSA annually and allow the assets to grow tax-free. Then in retirement they will have an accumulated bucket of money to help offset a portion of their medical expenses.
–? Contribute to a Roth IRA. If you are concerned about tax rates rising during your retirement years, you may want to consider contributing to a Roth IRA. Contribution limits are the same as for a traditional IRA; however, income limitations are different. While you will not be able to deduct your contributions, the earnings grow tax-deferred and can be distributed tax-free if you are over 59 A1/2 years old and have owned the Roth IRA for five years. Having some assets in tax-deferred accounts and some in tax-free accounts can let you better control your taxes in retirement.
I hope one or more of these ideas will help you reduce your taxable income for 2017. Before implementing any of these concepts be sure to consult with your tax professional about your personal situation. Start now to make 2017 a successful year!