Six Key Tax Planning Strategies for Individuals

Introduction

Tax planning is a cornerstone of financial success, allowing individuals to legally minimize tax liabilities and maximize financial growth. This detailed guide explores six effective strategies: deferring income, qualified charitable distributions (QCDs), retirement contributions, tax loss harvesting, bunching charitable deductions, and health savings accounts (HSAs). Each approach offers a unique way to enhance financial well-being while staying compliant with federal tax laws. Let’s explore these strategies in depth, complete with actionable advice and examples.

1. Deferring Income: Timing Taxable Income Strategically

Deferring income to a future tax year can be a powerful way to reduce your current tax liability, especially if you expect to fall into a lower tax bracket in the next year. This strategy works particularly well for individuals with variable income or those nearing retirement.

How It Works

Deferring income shifts taxable amounts from the current year to a future year, leveraging changes in tax brackets or deductions. Here are several practical examples:

• Employee Bonuses: If your employer offers flexibility, request that year-end bonuses be paid in January instead of December.
• IRA Withdrawals: Retirees can spread large withdrawals over two years, especially if the amount would push them into a higher tax bracket.
• Self-Employed Income: Delay billing clients or signing contracts until the new year to move income into a future tax period.

Case Study

John Doe, a 64-year-old earning $50,000 annually, plans to withdraw $40,000 from his traditional IRA to fund a home remodel. If he withdraws the full amount in one year, his taxable income jumps to $90,000, and his tax liability increases significantly. By splitting the withdrawal into two $20,000 distributions over consecutive years, John reduces his total taxes by $700 and avoids a year of higher tax bracket exposure.

Key Takeaway: Deferring income is most effective when you expect a lower tax burden in the future. However, this strategy should not result in paying more taxes across the years combined. Always consult a tax professional for personalized guidance.

2. Qualified Charitable Distributions (QCDs): A Tax-Efficient Way to Give

Giving back to your community while reducing taxes is a win-win situation. Qualified charitable distributions (QCDs) offer individuals aged 70½ or older a unique opportunity to fulfill their charitable intentions while minimizing taxable income.

How It Works

QCDs allow taxpayers to donate directly from their IRA to a qualified charity without including the distribution in their taxable income. These donations can count toward required minimum distributions (RMDs) for individuals aged 73 or older.

Benefits of QCDs:

• Excludes donation amounts from adjusted gross income (AGI).
• Reduces taxable income while supporting charities.
• Enables taxpayers to claim the standard deduction without forfeiting the tax benefits of charitable giving.

Practical Considerations

1. The maximum annual QCD limit in 2024 is $105,000 per taxpayer.
2. The IRA custodian must transfer the funds directly to the charity. A personal withdrawal followed by a donation disqualifies the QCD.

Example

Jane, a 75-year-old retiree, must withdraw $50,000 as her RMD in 2024. She donates $10,000 directly to her favorite charity via a QCD. This reduces her taxable income to $40,000, saving in taxes while supporting her cause.

Key Takeaway: QCDs are particularly beneficial for retirees who no longer itemize deductions due to the higher standard deduction.

3. Retirement Contributions: Building Wealth and Cutting Taxes

Retirement account contributions remain one of the most efficient ways to reduce taxable income and grow wealth tax-deferred or tax-free.

Types of Retirement Accounts

1. Traditional IRAs and 401(k)s: Contributions reduce current taxable income. Earnings grow tax-deferred, and distributions are taxed upon withdrawal.
2. Roth IRAs and 401(k)s: Contributions are made after-tax, but qualified withdrawals are tax-free. This will save you taxes in the future, not on your current income.
3. SEP IRAs and Solo 401(k)s: Tailored for self-employed individuals, these accounts allow higher contribution limits based on earnings.

Contribution Limits (2024)

• 401(k): $23,000 + $7,500 catch-up for those aged 50+.
• Traditional IRA: $7,000 + $1,000 catch-up for those aged 50+.
• SEP IRA: Up to $69,000 or 25% of self-employment income.

Advanced Strategies

• Backdoor Roth IRA: High-income earners can contribute to a nondeductible traditional IRA and convert it to a Roth IRA, bypassing income limits for Roth contributions.
• Catch-Up Contributions: Older taxpayers nearing retirement can supercharge their savings with additional contributions.

Example

A 55-year-old self-employed consultant earning $150,000 contributes $30,000 to a SEP IRA, reducing their taxable income to $120,000. This results in immediate tax savings while bolstering retirement funds.

Key Takeaway: Maximize contributions to tax-advantaged accounts every year to reap long-term financial benefits.

4. Tax Loss Harvesting: Turning Market Losses into Tax Savings

Market volatility presents opportunities to strategically sell losing investments and offset taxable gains.

How It Works

1. Sell investments at a loss to realize a tax-deductible loss.
2. Use losses to offset gains from other investments or up to $3,000 of ordinary income annually.
3. Carry forward unused losses indefinitely to future tax years.

Avoiding the Wash-Sale Rule

The wash-sale rule disallows claiming a loss if the same or a "substantially identical" investment is purchased within 30 days before or after the sale. To maintain your portfolio balance, consider investing in a similar but not identical fund or stock.

Example

Mark, an investor, realizes a $10,000 loss by selling underperforming stocks. He offsets $5,000 in gains from other investments and $3,000 of ordinary income, reducing his tax liability by $1,800 (assuming a 22% tax rate). He carries the remaining $2,000 forward to next year.

Key Takeaway: Tax loss harvesting is most effective when combined with a broader investment strategy.

5. Bunching Charitable Deductions: Amplify Your Tax Savings

With the standard deduction now higher, fewer taxpayers itemize deductions. Bunching charitable contributions helps surpass the standard deduction threshold, maximizing tax benefits.

How It Works

Instead of spreading charitable contributions evenly across multiple years, concentrate them in a single year. This approach allows you to claim higher itemized deductions in one year and take the standard deduction in subsequent years.

Using Donor-Advised Funds (DAFs)

DAFs let taxpayers make a lump-sum contribution for an immediate tax deduction while granting funds to charities over time. This provides flexibility and control over giving.

Example

John and Jane, a married couple, donate $10,400 annually to their church. In 2024, they double their contributions to $20,800. Combined with other itemized deductions, their total exceeds the $29,200 standard deduction for married couples, yielding a larger tax benefit for that year.

Key Takeaway: This strategy is especially effective for consistent charitable donors.

6. Health Savings Accounts (HSAs): The Triple Tax Benefit

HSAs offer unparalleled tax advantages, making them a must-use tool for individuals with high-deductible health plans (HDHPs).

Key Benefits

1. Tax Deduction: Contributions reduce taxable income.
2. Tax-Free Growth: Earnings grow tax-free.
3. Tax-Free Withdrawals: Funds used for qualified medical expenses are tax-free.

Contribution Limits (2024)

• Individual: $4,150
• Family: $8,300
• Catch-Up (55+): $1,000

Example

Sarah contributes $5,000 to her HSA in 2024 and uses it to pay for a $4,000 surgery. She saves on taxes and avoids paying for the surgery out-of-pocket.

Key Takeaway: Unused HSA funds roll over indefinitely, making them an excellent long-term savings vehicle for healthcare costs.

Conclusion

Smart tax planning is the foundation for long-term financial success. Tax planning requires a proactive approach tailored to your unique financial situation. By employing strategies such as deferring income, leveraging QCDs, maximizing retirement contributions, harvesting losses, bunching deductions, and using HSAs, individuals can significantly reduce their tax burden while advancing their financial goals. For tailored advice, consult me on the page below so I can help you implement these strategies effectively. 

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.