Tax Planning Strategies to Maximize Your Savings

Summary: Specialized savings accounts may help to lower your tax obligation and protect your savings.

When it comes to your finances, few things are as reassuring as having savings you can dip into for emergencies as well as developing your long-term plans. But to build your savings, you need to practice financial discipline and make smart decisions.

Applying the right tax planning strategy is one of those decisions. Tax planning can help you increase your contributions to a savings or investment account. It can also reduce your tax obligation, enabling you to build long-term financial stability.

Five tax planning strategies to maximize your savings

1. Contribute to a retirement account

Making regular contributions to a 401(k) or traditional IRA isn’t just a good way to prepare for retirement, it comes with important tax benefits. These retirement accounts are tax-deferred, which means the money you contribute and the interest you earn on it are not taxed until you start making withdrawals.

A tax-deferred retirement account can also lower your taxable income in the current year. This could help you save a significant amount of money on taxes.

2. Take advantage of employer savings accounts

Some employers offer Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs), which are tax-deferred accounts that can be used to save for health or dependent care expenses. To qualify for an HSA, you have to enroll in a high-deductible health plan (HDHP). It’s important to remember that contributions to FSAs expire at the end of each year, while contributions to HSAs do not.

You can use HSAs for certain qualified medical expenses, and you will gain three important tax advantages:

1. The money you contribute is with pre-tax dollars, which helps to lower your taxable income.
2. Your account earns interest and grows tax-free.
3. Withdrawals are also tax-free as long as you use them for qualified medical expenses.

There are two different types of FSAs: healthcare and dependent care. You can use healthcare FSAs to save for certain medical expenses, like deductibles, co-payments and prescription medications.

Dependent care FSAs, as the name suggests, help you save for expenses on people you claim as dependents on your income taxes. You can use them for childcare, preschool, after-school programs and adult daycare.

3. Set up an education savings account

Contributing to a 529 education savings account (ESA) is a great way to save for an education program. You can use it to help cover K-12 education, college and apprenticeships.

The growth in these accounts is tax-deferred and may be tax-free if withdrawals are used for qualified expenses, like tuition, books, fees, supplies, and room and board. Note that contributions to the accounts are made after-tax, and in some states, you can enjoy tax deductions for contributions up to a certain amount.

There are two types of 529 plans: college savings plans and prepaid tuition plans. A college savings plan is highly flexible and covers several qualified expenses. You can use it at any qualifying educational institution. Prepaid tuition plans have the unique benefit of allowing you to lock in current rates by prepaying tuition at a specific college or university system. Considering how fast tuition is increasing, a prepaid tuition plan could help you pay your way or your child’s way through college.

4. Look for tax deductions

Taking all of the legal tax deductions that you are due is another strategy that can help maximize your savings. A tax deduction is an expense that you can subtract from your income to reduce the amount that is taxable.

Deductions help lower your taxable income, which reduces your tax liability and allows you to save more. The U.S. Government offers a variety of tax deductions to encourage certain investments and activities.

Some common tax deductions include:

• Mortgage interest
• State and local taxes (SALT)
• Charitable contributions
• Job-related expenses
• Student loan interest
• Certain higher education expenses
• Business expenses
• Home office deduction

The IRS allows you to take either a standard deduction or to itemize your deductions. Note that itemizing will only be beneficial to you if the total is more than the standard deduction.

5. Check if you qualify for tax credits

Similar to tax deductions, tax credits may also lower your taxes. A tax credit is a reduction in the amount of income tax you owe. The U.S. Government offers tax credits as a way to encourage certain activities or to provide financial relief.

Some common tax credits include:

• Child tax credit
• Earned income tax credit (EITC)
• American opportunity credit
• Lifetime learning credit
• Child and dependent care credit
• Energy efficiency credits

Talk to financial and tax experts

The tax code is complex. And while you’re working hard to provide for yourself and your loved ones, it can be challenging to research and implement the right tax planning strategies. Here’s where consulting with a tax professional comes in handy. Although you will have to pay a fee for the service, a tax professional can help ensure that you take every legal deduction and credit that you are due.

As you take stock of your personal finances, it might also be helpful to engage a financial advisor. A qualified financial advisor will use your personal preferences and risk appetite to design a customized financial plan replete with recommendations around investments and deductions. You can follow the plan to help grow your savings and reach your financial goals.