Can Your Money Work for You? Tax Planning in 2020

If there’s an aspect of financial planning that’s leading the pack in the running for Most Neglected, it’s probably tax planning. We all pay taxes, so it’s something we’ve all got to do to some extent, and many view it as a chore. This is unfortunate, as intelligent tax planning can potentially save you significant amounts of money.

Part of the problem is perspective. People simply don’t see tax preparation for what it is: a money-making opportunity. By taking efforts to reduce your tax obligations, you’ll see more of the wealth you’re creating.

Another part of the problem is that tax law is quite complicated. There’s a reason that there are professions dedicated entirely to tax planning. It takes years of study to get acquainted with the law and then years of experience dealing with tax planning before one is able to do it properly. Check out the Taxpayer Roadmap on the IRS website to see for yourself.

All of the above means that it takes plenty of careful considerations to achieve an effective tax plan. You’ve got to consider the timing of your income and purchases, the contributions you make to retirement accounts, and relevant tax deductions.

It’s a lot to take on, and consulting a certified tax professional is definitely the safest option, but educating yourself is also essential.

 

Tax Planning for Retirement

Planning for retirement is another important aspect of financial planning. Doing it well means that you’ll be comfortable in your golden years and won’t have to worry about money once you stop earning a paycheck.

There are several different types of retirement plans, and many people have more than one, but they all have tax implications. We’ll look at the differences between a 401k, a traditional IRA, and a Roth IRA.

 

The 401K

This is a very popular retirement savings plan, especially for employees of large companies. The 401k plan offers the ability to have part of your paycheck put directly into your retirement account. This is an effective way to reduce your taxable income while you’re making contributions.

Another benefit of this plan is employers often offer to match the contributions of employees, up to a certain dollar amount.

The taxes that are deferred because of contributions to this type of plan are payable upon withdrawal of the funds in retirement.

 

Traditional IRAs

These accounts are also quite popular, and where 401k plans are generally only available through an employer, anyone can open a traditional IRA. Another difference between these two types of plans is that the contribution limit is lower with IRAs.

The IRA contribution limit in 2020 is $6,000. If you’re over 50, this number increases to $7,000. As with a 401k, taxes on these contributions will be deferred until you begin making withdrawals from your account in retirement. At this point, they will be treated as normal taxable income.

 

Roth IRA

This is similar to the traditional IRA in that anyone can open one. The major difference between the two is that contributions to your Roth IRA are taxed. The tradeoff is that your withdrawals from the account later in life won’t be taxed. These accounts are typically recommended for people who expect to be in a higher tax bracket later in life when they’re making withdrawals from the account.

 

Using the tax advantages of your retirement accounts wisely is one aspect of responsible tax planning.

 

Health Savings Accounts (HSAs)

In addition to planning for retirement costs, you’ll also need a way to fund future healthcare costs. Fortunately, there’s a tax-efficient way to do this as well.

HSAs are available to U.S. taxpayers who are enrolled in a High-Deductible Health Plan. They can be a great way to reduce your tax bill while saving for medical costs. Contributions to HSAs are tax-deductible, grow tax-free, and can be used to pay for qualifying medical expenses without any tax penalty.

While they may seem like the perfect plan, they aren’t without some drawbacks. For example, there are often monthly maintenance fees associated with having an account, and there are penalties for making non-qualifying withdrawals.

Seeking professional guidance is one of the only sure ways to know whether an HSA makes sense for your health and tax situation.

 

Tax Deductions

The first thing that comes to many peoples’ minds when thinking about tax planning is deductions. Tax deductions are amounts of money that can be subtracted from your taxable income, reducing the amount of income tax you’ll need to pay. These are different from tax credits, which actually lower your tax obligation directly, dollar for dollar.

There are two ways to apply deductions in preparing your taxes, taking the standard deduction and doing itemized deductions.

 

Standard Deduction

Claiming the standard deduction is the quickest and easiest way to deal with deductions. The government offers a standard deduction amount that you can use to reduce your taxable income, no questions asked. This number rose in 2020, and the amount depends on your filing status.

For those filing as Single, the 2020 standard deduction is $12,400. This is up from $12,200 in 2019.

For those married filing jointly, the 2020 standard deduction is $24,800. In 2019 it was $24,400.

 

Itemized Deductions

It’s pretty intuitive. This option makes more sense for those whose itemized deductions equal more than the standard deduction amount.

This process can be time-consuming and is usually pretty complex. You’ll also need to provide the IRS with proper documentation for each of these deductions. Enlisting the help of tax experts is one of the best ways to make sure you’re taking advantage of all of the deductions that are available to you.

 

Understanding Your Tax Bracket

The rate at which you’re taxed depends on the size of your taxable income. In the U.S., tax rates increase with higher taxable incomes. However, there are some common misunderstandings surrounding this concept.

The lowest tax bracket has an income tax rate of 10%, and the highest tax bracket requires taxpayers to pay income taxes at a rate of 37%. This doesn’t mean that those in the highest tax bracket pay a flat 37% on their entire taxable income. They only pay that percentage on the amount of taxable income that falls above the highest threshold.

A detailed breakdown of federal tax rates for 2019 and 2020 can be found on the IRS website.

The best type of tax planning includes a keen awareness of tax brackets. By timing your income (if possible) and making timely tax-advantaged contributions to retirement funds or charities, you can greatly reduce what you’ll need to pay in income taxes.

 

Tax Refunds

One of the few perks of tax filing season is finding out that you’ll have a tax refund coming your way. In 2019, there were more than 111 million refunds issued. If you’re lucky enough to be one of those who will be receiving a tax return this year, you’ll want to make sure you actually get it!

With such a huge number of returns to issue, the IRS can take up to six weeks to deliver your money by mail. This is a long time to wait, especially if you’ve got plans for that money.

Fortunately, the IRS has a tool you can use to keep track of your refund. It’s updated every day and is a great way to achieve peace of mind when it comes to wondering when you’ll see your refund.

 

Tax Planning for the Future

Taxes aren’t going anywhere. You’ll have to file by April 15 this year just like you did last year, and 2021 is going to be quite similar. Those with the most robust financial situations know that this is more of an opportunity than an obligation. All it takes is some education and trusted professionals to guide you to your best tax scenario.

While the information in this post is a great place to start and should give you some useful tools for tax planning this year, it really just touches on the basics. Every financial situation is unique, and the best tax planning methods will be different for each individual. People who own businesses, for example, will have to take extra considerations.

It’s never too early in the year to start tax planning preparations. In fact, regularly revisiting your tax plan throughout the year is always the best approach. Your financial situation will continue to change as the years pass and you enter new phases of life, and your tax plan should change with it. To be sure you’ve got the right tax plan for 2020 and beyond, enlisting professional help and guidance might be your best investment yet.

 

We Can Help

Choosing someone to help plan your taxes is no easy feat, but that’s why we aim to be as open and available as possible. We hope that this post shed some light on an intimidating subject.

The Saddock Advisory team invites you to get in touch with us so you can learn more about our history, our services, and how we can help you! Fill out our contact form here and we’ll be in touch shortly!

 

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Can Your Money Work for You? Tax Planning in 2020
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Tax planning is starting to be on everyone's mind, whether for personal or for business tax preparations. Here's what you need to know.
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