With April 15 quickly approaching, it seems like taxes are on everyone’s mind right now.
It’s also at this time of year when people get really motivated to reduce their taxes. Do you need some motivation? Look at line 61 on your 1040 form to see how much federal income tax you paid last year. Gulp! That’s not even counting state income tax, property tax, sales tax and, sometimes, gift and estate tax. Who says you’re not patriotic?
Now that I have your attention and you’re good and motivated, we’re going to walk through a simple but effective way to help lower your taxable income. No, we’re not going to double-check deductions, exemptions or credits. And it’s not tax-free bonds (although that’s a good guess; munis are great for tax-free income). It’s certainly not buying that index annuity your insurance agent recommends.
What is it? An easy to implement and less pressure-filled way to lower your taxable income: Increase contributions to your employer-sponsored retirement plan. It’s easy to do, it lowers your taxable income and you’re further securing your own retirement. Isn’t it funny how sometimes we don’t see the obvious?
When people come into our office, we examine their tax returns, looking carefully for ways to reduce their taxes. We don’t look at your tax return only once, but every year. 401(k) participation is an example of things we look for.
It’s funny. Someone will come in upset – and rightfully so – about how much they pay in taxes, yet they’re not maxing out contributions to a 401(k) plan. Then we see they have large balances in their checking and savings accounts crawling along at a quarter percent interest. And they’re paying tax on that little tiny dab of interest at their highest tax bracket. So what they are doing is they’re putting too much into a taxable savings account and not enough into a tax-deferred 401(k) plan.
Wouldn’t it be better to let that money grow with no tax in your 401(k) plan rather than pay high taxes in a savings account?
The amount you can add to a 401(k) plan for 2015 is the lesser of $18,000 or 100 percent of the employee’s compensation. Also, if you’re age 50 or older, you can make an additional catch-up contribution of $6,000. So you potentially could defer salary up to $24,000 into a 401(k) plan. This directly lowers your taxable income.
For example, if you are in the 28 percent tax bracket and you increased your 401(k) contribution by $10,000 you would save $2,800 in taxes for the year. What could you do with $2,800? You could very well move yourself into a lower bracket by increasing contributions. Now we’re talking.
Again, it is very simple to do. You’re lowering your taxes and helping yourself better prepare for retirement.
• Mike Piershale, ChFC, is president of Piershale Financial Group. Send any financial questions you wish to have answered in this column to Piershale Financial Group Inc., 407 Congress Parkway, Crystal Lake, IL 60014. You also may fax them to 815-455-6895 or email email@example.com.