Tax deadlines are quickly approaching, which means many of us are scrambling to find ways to reduce our taxable income before signing the dotted line or clicking the submit button. Hope is not lost, though, as families and individuals still have time to implement a few income reduction strategies and save for the future. With topics ranging from education planning to retirement savings, this article will highlight a few ways taxpayers may still lower their taxable income before the approaching April 15 tax filing deadline. Those methods include:
Saving for Education
While most states have adopted a 529 College Savings Plan, and perhaps even offer tax incentives for contributions, our professionals at Forvis Mazars often find these incentives only exist for contributions made in the current year, or before December 31. However, some states have started to expand this benefit and now allow contributions to be made through the tax filing deadline (most commonly April 15 unless changed due to a holiday). Further, if your state of residence offers a 529 plan without a state income tax incentive, or if your state of residence does not have state income tax, it may be worth exploring other states’ plans, especially if you pay income tax in multiple states. Many states now offer nonresident income tax breaks for contributions made to their state plan.
Taxpayers in the following states now have until the April tax filing deadline to make qualifying contributions to their 529 for the prior year: Georgia, Indiana, Iowa, Mississippi, Oklahoma, South Carolina, and Wisconsin.
After years of saving and investing for college, there may come a time where the 529 is no longer needed. Although proper planning may limit what is left over, families often struggle with how to handle these leftover funds in an unused 529. Recent tax law changes have expanded planning opportunities associated with leftover 529 funds, which is a topic explored in our FORsights™ article, “529 to Roth IRA Rollovers – A New Planning Opportunity?”
Retirement Savings & IRA Contributions
Aside from retirement plans offered through your employer or business, the IRS also allows individuals to save for their retirement via individual retirement accounts (IRAs). Contributions for the prior year may be made through the tax filing deadline. Even better, though, is that a contribution before the deadline could potentially reduce your taxable income while also boosting your retirement savings. The income reduction component of this is entirely dependent upon your earned income for 2024, so pay close attention to your income and associated deduction limits before jumping in on a last-minute IRA contribution.
The maximum amount you can contribute to all your IRAs (traditional or Roth IRA) in 2024 is the lesser of 100% of your earned income or $7,000 ($8,000 if you are age 50 or older).
Anyone with earned income can open an IRA and make contributions. The amount individuals and families are entitled to deduct, however, is a different story. Please reference the IRS site to determine your deductibility limits based on your or your family’s income and/or participation in any other retirement plan.
You Know Your Deduction Limits, but Would a Last-Minute IRA Contribution Make Sense?
In general, setting aside additional wealth for retirement should always be viewed as a positive. Where to direct those deposits, though, is more important than deciding whether you should make one. If you are trying to reduce your taxable income and/or are eligible for a full or partial deduction, getting the deposit in before the deadline could be of great benefit for you. But what if you are ineligible for a full or partial deduction benefit, or reducing your income is not a factor? You may find greater tax advantages by contributing to a Roth IRA.
While traditional IRAs may offer a current-year tax benefit for contributions made to the account, Roth IRAs are the opposite. A Roth IRA allows individuals to contribute after-tax dollars—or money that has already been taxed—in exchange for tax-free investment growth, as well as tax-free withdrawals (depending on when you begin withdrawing or using the funds). This exchange also means tax deductions are not offered on Roth contributions. Much like the deduction limits on a traditional IRA, the government also has imposed contribution limits to a Roth IRA based on earned income. These limits are more commonly known as income phaseout limits. Please view the IRS site to determine where you or your family may land regarding income and Roth IRA phaseout limits.
If you are a high-wage earner, or a younger professional with high-income potential later in your career, it may make sense to consider forgoing the tax benefit today in exchange for tax-free growth and distributions later in retirement via the Roth. Regardless of circumstance, we are currently in an environment of historically low tax rates. For some, this may make it a bit more favorable to forgo the current-year tax deduction with a traditional IRA in exchange for the tax-free growth with a Roth.
Strategies if Ineligible for Both Traditional IRA Tax Breaks & Roth Contributions
Many Americans may find themselves in a situation where their income—or that of their family (married filing jointly or otherwise)—makes them ineligible for both traditional IRA income tax deductions and Roth IRA contributions. Where do you turn next? This is where a back-door Roth IRA may come in handy.
The back-door Roth IRA is a retirement savings strategy where funds recently contributed to a traditional IRA (nondeductible contributions) are converted to a Roth IRA to fund the Roth IRA without income limitations. This strategy is most useful for individuals who do not otherwise carry an IRA balance, as this conversion method could potentially trigger the application of pro rata taxes. While a back-door Roth is legal and permissible by the IRS, there may be other tax laws that need to be met or considered.
While the process of opening a traditional IRA, making a nondeductible contribution, and then converting this amount to a Roth IRA is simple, there may be scenarios where hidden taxes could derail your intentions. To prevent these tax issues from impacting your plans, we would suggest consulting a CPA or tax preparer for additional guidance and support.
Health Savings Accounts (HSAs)
One constant these days is the ever-rising cost of healthcare. While health insurance is a great tool to help mitigate the risk of rising healthcare costs, another great option is the HSA. Participation in an HSA is dependent upon participation in a high-deductible health plan (HDHP). This is explored in another FORsights article, “HSAs: A Great Way to Save & Pay for Current & Future Medical Expenses.”
If you or your family were HDHP participants in 2024, you are likely eligible to contribute to an HSA. Similar to IRAs and some 529s, you have until the tax filing deadline to make contributions for the prior tax year. While most participants typically make their annual contributions via payroll deduction through their employer, you also may make direct contributions via check or bank transfer. Although there are limits on annual contributions based on self-only HDHP coverage versus those with family HDHP coverage, the HSA does not impose income limitations like that of IRAs.
Contributions to an HSA are considered above-the-line deductions, or deductions that reduce your adjusted gross income before tax, regardless of your earned income. Earnings on your contributions accumulate tax-free, and any funds distributed or withdrawn for qualified medical expenses for the account beneficiary are withdrawn tax-free as well. Most medical expenses are generally considered qualified for purposes of tax-free withdrawals, but there may be limitations or additional physician authorization needed for others. IRS Publication 502 sheds some light on qualified expenses. Funds withdrawn prior to age 65 for non-qualified medical expenses for a beneficiary of the account may be subject to ordinary income tax, plus a 20% penalty. Funds used after age 65 for non-qualified medical expenses are still subject to ordinary income tax; however, the penalty is dropped. The lack of penalty on non-qualified distributions after age 65 makes the HSA an overlooked retirement savings vehicle.
Although the HSA is a great tool for accumulating additional wealth and combating the rising cost of healthcare, it is not meant for everyone. We recommend choosing the healthcare plan that best fits your family’s needs and financial circumstances and not solely on the ability to participate in an HSA. As with most other things in life, this is not meant to be a one-size-fits-all solution.
Additional Considerations
The ideas above are not meant to be an exhaustive list of all strategies or solutions available. There is a multitude of options for individuals who are employed and offered retirement plans through their employer, are a business owner, or are self-employed. For those seeking additional options and considerations beyond IRAs, HSAs, and 529s, please reach out to a professional at Forvis Mazars.