Part of our build your own financial plan series
How to keep more money this tax season? These 10 tips can help.
Want to keep more of your hard-earned money? Tax planning can help.
File on time. The federal filing deadline has been extended for the second year in a row. Submit yours by the new deadline of May 17, 2021, or file for an extension to avoid hefty fees. State tax deadlines may vary, so check with your state’s department of revenue.
Next, keep tabs on changes not only to your situation, but tax rules and laws. A tax professional can help.
Then, use our tax planning worksheet (PDF) to think through potential savings from tax credits and deductions.
Finally, consider these 10 tax-saving strategies for 2021.
Tax-prep tip: Why lower your taxable income? Less income to tax = lower taxes. And that can mean more money in your pocket.
1. Increase retirement account contributions.
Any 401(k) or 403(b) contributions taken from your paycheck on a pre-tax basis reduce your taxable income (that’s the amount of your income the government can tax). Your contributions to a traditional IRA may also be on a pre-tax basis (for those eligible to deduct their contribution) and therefore lower your annual gross income (AGI), too.
Whether you can take a tax deduction depends on how much you make and if you have access to a retirement plan at work. In 2020, the max you could contribute to an IRA stayed at $6,000. Learn more about IRAs.
Navigating your retirement accounts and taxes
|Are you 72 or older?||You didn’t have to take a required minimum distribution (RMD) from your IRAs in 2020 based on the CARES Act, but you will have to in 2021 (and pay tax on it, too).|
|Are you self-employed or have a business?||Consider saving in a SEP or Simple IRA.|
|Consider making a catch-up contribution if you’re 50 or older.||Contribute an additional $6,500 to a 401(k) or 403(b) plan, or $1,000 to an IRA beyond the standard limits.1|
|Do you want to avoid taxes when you make a withdrawal?||Think about a Roth IRA; you pay taxes now, but enjoy qualified tax-free withdrawals later.2 Take this quiz (PDF) to see if a Roth IRA could be right for you.|
|Are you ready or able to speed up your retirement savings?||Think about bumping up contributions to your 401(k) or 403(b) plan contribution limits vary each year.|
2. Boost your savings in a 529 college savings account.
A 529 plan is a tax-advantaged way to save for education-related expenses. You contribute with after-tax dollars, but earnings are tax-deferred while invested.
More than 30 states plus the District of Columbia offer state income tax deductions or credits for contributions to a 529 college savings plan. Tax benefits differ by state and how much you contribute to a 529 plan during a tax year. Learn more about Tax Benefits for Education (PDF) from the IRS.
3. Contribute to your Health Savings Accounts (HSAs).
This is another one that may be tied to your employee benefits at work. If a high deductible health plan (HDHP) is offered and you choose it for your medical coverage, you can contribute to an HSA to save for out-of-pocket medical expenses not covered by your plan.
There are lots of rules around HSAs, so visit the IRS website to learn more.
4 HSA advantages
|Tax?||Money added isn’t taxed.|
|Growth?||Accounts grow tax-free.|
|Withdrawals?||Withdrawals for qualified medical expenses aren’t taxed.|
|Retirement?||The account can be used in retirement.|
4. Improve your home’s energy efficiency.
The residential energy efficient property credit allows homeowners to claim 30% of the cost of alternative energy equipment (including installation). That eligible equipment includes solar hot water heaters, solar electric equipment, wind turbines, and fuel cell property.
If you do any home efficiency installs, hang onto your receipts. Learn more about energy tax credits on the IRS site.
5. Open a Flexible Spending Account (FSA).
It’s a great way to “pre-save” for expenses you know you’ll have, such as childcare, elder care, medical expenses, or prescriptions. If an FSA is available through your employer, every dollar you put in lowers your taxable income. The money comes out of your paycheck on a pre-tax basis. Then you submit expenses for reimbursement as they occur.
If you don’t have an FSA option, take a look at the Dependent and Child Care Tax Credit instead. (Some restrictions apply, so consult your tax professional.)
FAQ for your FSA
|What’s the max you can set aside?||$2,750; $5,000 for dependent care in 2021.1|
|Carryover into another year?||No; use it or you lose it.|
|What can you use it for?||Some items may not be reimbursable; check first.|
|How does it affect your taxes?||Whatever you set aside may reduce your taxable income.|
6. Review your paycheck withholdings.
Check to see if you have too much, too little, or just the right amount taken from your paycheck for federal and state taxes.
Too much? The average refund in 2020 was $2,535, or about $211 a month.3 Maybe you have financial goals those extra dollars could help you meet—like beefing up emergency savings or paying down debt.
Too little? You could end up owing money (maybe even be charged a penalty). Luckily you can change your withholdings at any time.
Tax-prep tip: Use the tax withholding calculator on the IRS site so you know where you stand, withholding-wise. It only takes a few minutes.
7. Buy your own home.
If you become a homeowner and itemize mortgage interest and a portion of your property taxes, you may reduce your taxable income. Or, you can also take the standard deduction. Each person’s situation (and the pros and cons of that choice) can be different. A tax professional can help you review the effect on your tax plan.
Tax-prep tip: Several years ago, the standard deduction for each filing status increased significantly after recent tax reform. But if your total itemized deductions are more than the standard deduction, you can still claim deductible expenses on your tax return. Calculate it both ways and do what works in your favor.
8. Buy an electric-powered vehicle.
The amount of this tax credit depends on the size of the vehicle and its battery capacity, up to a max of $7,500. (Some states may offer credits, too.) In addition, the credit was set to expire after 200,000 qualified electric vehicles were sold in the U.S. by each manufacturer, but that may change. To check the status of that and learn more about tax credit amounts for specific cars, visit fueleconomy.gov’s pages about electric vehicles and plug-in hybrids.
9. Keep an eye on your investment portfolio.
If you have mutual funds and stocks, watch their performance during the year. Selling some securities at a loss by year-end to offset capital gains may help reduce your taxes. It’s called “tax-loss harvesting.”
But, it’s complicated. Consult a financial professional for guidance on this tactic.
10. Take every tax credit available to you.
That includes options like the child tax credit. Remember, the goal is to take all the credits you’re entitled to so that you reduce your tax bill. This credit, for example, let’s you deduct $2,000 per child under the age of 17, with a few income limitations and rules, of course.
Tax deduction: reduces the amount of income your taxes are based on.
- Example: $50,000 taxable income - $2,000 tax deduction = $48,000 new taxable income
Tax credit: reduces the total amount of income tax you owe.
- Example: $10,000 owed in federal income tax - $2,000 tax credit = $8,000 new total owed
- Brush up on the latest tax law changes: “Filing your 2020 taxes: What to remember.”
1 IRS annual limits for 2021.
2 Your account must be open for 5 years and you must be over age 59½ to be eligible for qualified tax-free withdrawals.
Investing involves risk, including possible loss of principal. Asset allocation and diversification do not ensure a profit or protect against a loss.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
Insurance products and plan administrative services are provided by Principal Life Insurance Company. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities are offered through Principal Securities, Inc., 800-547-7754, member SIPC. Principal Funds Distributor, Principal Securities and Principal Life are members of the Principal Financial Group®, Des Moines, Iowa, 50392.