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Paying less in income taxes can put more money in your pocket. Simple financial planning strategies-like using the right tax forms and preparing for the impact can help you reduce your taxable income.
You can use these strategies throughout the year, not just at tax time.
Let's explore these four tax-savings strategies:
Adjusting your income to stay in your target tax bracket is one way to manage taxes. You can do this by accelerating or deferring your income. For example, you can accelerate by using a Roth conversion to move your future income to the current year. Or you can defer income to a later year by contributing to retirement accounts like traditional IRAs and 401(k) plans. It's all about finding the right balance.
Ashley Greene, a Vanguard wealth planning specialist and co-author of the Fundamentals of tax planning: Beyond the basics whitepaper explained, “When you consider all the taxes you pay over time, paying more taxes today may net you the optimal results over the course of your lifetime.”
You gain capital when you sell personal property (e.g., real estate, cars, stocks, or bonds) at a profit. One way to manage capital gains is to limit taxable account transactions. There are different ways to do this, depending on what kind of property you’re selling and your individual situation. For instance, if you:
- Require income from your investments, you could use rebalancing proceeds or fund distributions throughout the year to meet your cashflow needs.
- Don’t require investment income, consider the tax impacts when you sell an investment or rebalance your portfolio. For example, you can manage capital gains by using the proceeds from rebalancing to fulfill your charitable contributions.
You may be entitled to deduct certain annual expenditures from your taxable income. To take advantage of both the standard and itemized deductions, you can shift multiple years' worth of deductible expenses into a single year. This strategy, known as bunching, is commonly used for charitable contributions and medical expenses. Depending on your state's laws, it may be applicable to other expenses as well.
“The combination of taking the standard deduction in some years, while taking itemized deductions in others, can increase total deductions over time,” Greene says.
Getting advice: How financial advisors and tax advisors can help
When it comes to financial planning and lowering your taxes, deciding which strategies to use and implement can be complicated. That’s why many people turn to a financial or tax advisor for help. Financial advisors can help you grow your wealth through investment and financial planning, asset location, and money management. Tax advisors—such as Certified Public Accountants (CPAs)—typically provide taxation services along with advanced accounting and some financial planning.
Along with some simple financial planning strategies you can use yourself, consulting with these professionals can help you boost your wealth and optimize your tax planning efforts.
Advisory services are provided by Vanguard Advisers, Inc. (VAI), a registered investment advisor. Eligibility restrictions may apply. VAI cannot guarantee a profit or prevent a loss.
Although the income from municipal bonds held by a fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.
The information contained herein does not constitute tax advice, and cannot be used by any person to avoid tax penalties that may be imposed under the Internal Revenue Code. Each person should consult an independent tax advisor about their individual situation.
