Did you end up getting dinged in taxes this year? Or maybe it was a whole lot more than dinged? Whether you paid out just a little or enough to cover the federal government for all those stimulus checks, you’re probably wondering if you’re making some tax mistakes.
Read on to find out six common mistakes that may be hurting your personal finances and how you can fix them to avoid paying extra taxes next year.
Mistake #1: Forgetting to Adjust Your W-4
No doubt, if you recently got married, the thing you were not thinking as you walked down the aisle was “I need to change my W-4!” But whenever you have a big life event—marriage, children, divorce, second job—take a look at your W-4.
Life transitions can change your tax status and rate and enable certain tax deductions and credits, such as the Child Tax Credit. Whenever your life changes, check to see if your W-4 needs to change too.
Mistake #2: Failing to Use Your 401(k)
If you have a 401(k) or another tax-deferred retirement account through your employer, then you have a way to save for retirement and reduce your taxes.
Your 401(k) contributions are made with pre-tax dollars, which means they end up reducing your taxable income. In 2021, you can contribute up to $19,500 to a 401(k), plus $6,500 more if you’re 50 or older.
Just remember: Few things in life are tax-free, and that includes your 401(k). You’ll pay taxes when you begin withdrawing money in retirement.
Mistake #3: Not Contributing to an IRA
Like your 401(k), a traditional IRA can also help build your retirement savings and catch a tax break—this time in the form of a tax deduction. But the IRS has rules about who is eligible for a tax deduction. (Note: Contributions to a Roth IRA are never tax-deductible.)
Even if you don’t meet the deduction requirements, an IRA can still help increase your retirement nest egg. If you meet the income rules, you can contribute up to $6,000 in 2021, plus a “catch-up” contribution of $1,000 if you are 50 or older.
Mistake #4: Not Taking Advantage of Tax Loss Harvesting
If you’re facing capital gains taxes because of some winning investments, a strategy called tax-loss harvesting may come to the rescue. With tax-loss harvesting you use losses to offset gains. You can also use your net loss to offset up to $3,000 in ordinary income.
Not only can you use harvesting in the year you sell the losing investments, you can carry forward any “excess” losses. That means you can continue to offset capital gains and reduce income taxes indefinitely, making this a potentially powerful addition to your tax-reducing toolkit.
Mistake #5: Ignoring Your Charitable Instincts
The Tax Cuts and Jobs Act increased the standard deduction enough that a lot of people are no longer itemizing, which means they are no longer relying on a tax deduction for charitable giving to reduce their tax bill.
If that’s you, you don’t need to squelch your generosity. Instead, check into whether a “bunching” strategy will work for you. With bunching, you make two or more years’ worth of donations in a single year—enough so that itemizing is a viable strategy to reduce your taxes. You then wait a year or two until you’re ready to bunch your contributions again.
There’s an issue with this strategy, though: Many nonprofits rely on regular, recurring contributions. But if you use a donor-advised fund, you can contribute to the fund one year, get the tax benefits, and then make grants to the nonprofits on your schedule.
Mistake #6: Waiting Until April to Think About Taxes
We’ll close this article with a crucial mistake people make, and that’s thinking of tax planning as a one-time activity, like spring cleaning. Instead, we recommend that you think of tax planning as a year-round activity.
By getting into the habit of reviewing potential tax strategies throughout the year, you’ll be in a better position to seize opportunities when they come along. If you’re waiting until April 15 to think about your tax return, you’re really too late.
Consider working with a financial advisor who will include tax planning as part of your financial plan. Our Plantation, Florida fee-only wealth management firm helps clients integrate year-round tax strategies as part of their long-term financial planning.
Schedule a complimentary consultation with one of our fee-only financial planners to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.