Now that the year is almost spent, many people are trying to figure out what they can do to reduce their tax liability. Now is a good time to prepare your finances for the end of the year, and try to figure out the best way to reduce what you owe. One way to do that is by lowering your taxable income with the help of deductions. Happily, there are some accounts that you can open that provide you with a tax deduction now, while at the same time setting you up for a better financial future. Here are two different types of accounts to consider as you plan your end of the year financial moves to help reduce your tax liability:
You can open a 401k or a Traditional IRA and deduct the contributions. (Sorry: If you open a Roth account, you don’t get the tax deduction.) If you work for a school or a church, you can contribute to a 403b and enjoy to the regular (not the Roth) version of this plan. You contribute now, and lower this year’s taxable income.
However, you should remember that, even though you receive a tax benefit now, you will eventually have to pay taxes. Your earnings grow tax deferred until you withdraw the money. At that point, you pay income taxes on the amount you withdraw. If you are in a higher tax bracket at retirement, this can be something of a disappointment later on. But, if you need the tax deduction now for cash flow reasons, it can be a good move to open a non-Roth retirement account.
The benefit, of course, is that the money goes into an account that build on your behalf. So, you have the chance to increase your wealth through an investment portfolio, in addition to the tax break for this year.
Health Savings Account
Open enrollment is upon us, and now might be the time to switch to a high deductible plan, and open a Health Savings Account. You fund your Health Savings Account with pre-tax dollars, so it counts as a deduction. This is a great way to make your health care expenses tax deductible: Contribute to your HSA, get the tax deduction, and then use the funds in it to pay for qualified health care expenses.
The great thing about the HSA is that you never have to pay taxes on the money as long as you use the funds for health care expenses. (If you withdraw the money for something other than qualified expenses, the HSA acts just like a traditional IRA.) Your money grows as well (even though the yield is usually more in line with a high yield savings account), and it remains yours. You are required to have a high deductible plan, though, so you want to make sure that you aren’t going to end up paying too much out of pocket. Carefully consider your health needs before committing to such a plan.
Opening a tax advantaged account right now can help you lower your tax liability for this year, while at the same time helping you establish accounts that will benefit you down the road. Remember, though, that there are qualifications, contribution limits and other restrictions that might go with these plans. Make sure you understand them before you begin to contribute.