If you consistently owe taxes each year, you may want to try using investments to lower your taxable income. These investments allow you to set aside funds in a way that will reduce the total amount of your income that the IRS can tax. In this article, we will explain how to use these 5 investment strategies that can lower your taxable income.
Save for Retirement
One of the easiest investment strategies you can use to lower your taxable income is to take advantage of saving for retirement. How can you do this? The first way is through an employer-sponsored retirement plan, like a 401(k) or a 403(b). In 2021, these plans allow you to contribute up to $19,500 of your pretax income. If you are 50 or older, this amount increases to $26,000. These funds are taken out of your paycheck and reduce your taxable income by the amount you contribute during the year. Second, you can use an Individual Retirement Account or an IRA. In 2021 you can contribute up to $6,000 of pretax funds. Or $7,000 if you are over 50 years old. These contributions also reduce your taxable income by the amount contributed.
Flexible Spending Account
A Flexible Spending Account is a special type of account offered through your employer. These accounts allow you to divert pretax funds to specifically pay for medical expenses. In 2021 you can use an FSA to set aside up to $2,750 of your taxable income. The biggest drawback is that if you do not use the funds to pay for eligible medical expenses, you may lose the unused funds at the end of the year.
Health Savings Account
A Health Savings Account that allows you to set aside pretax funds that you can use to pay for qualifying health care expenses. You can only utilize an HSA if you have a high-deductible health insurance plan. If you fit in that category, an HSA is a very helpful planning tool. It helps you simultaneously reduce your taxable income and reduce your health care costs. For the 2021 tax year, you can contribute up to $3,600 for an individual or $7,200 for a family. In 2022 the contribution amounts will rise to $3,650 for an individual and $7,300 for a family.
Properly Allocate Investments
One of the best tax planning strategies you can make is to properly allocate your investments into the appropriate type of investment account. Preplanning what you place in a retirement account versus a standard brokerage account can greatly reduce your taxes. It is advantageous to purchase high-dividend investments in your retirement accounts. This will prevent you from having to pay taxes on these dividends each year.
You also need to be conscientious about how you trade investments in your standard brokerage account. If you make substantial profits, you will have to pay capital gains on the income you generate in this way. However, such trading done in a retirement account will allow you to defer paying taxes on this income until you withdraw it during your retirement.
1031 Exchange for Investment Properties
Selling an investment property can create a large tax burden, as there is no exclusion amount on the sale of investment properties. A 1031 exchange allows you to exchange one rental property for another. Doing so allows you to defer paying capital gains tax on the property to a later date.
Implementing These 5 Investment Strategies That Can Lower Your Taxable Income
If you would like to implement these 5 investment strategies that can lower your taxable income, meet with a qualified tax preparer. They can help you to find which will work best for you in your situation.
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