We’re still a month away from Tax Day, so now’s the time to take action and save yourself some money on taxes.
Many Americans think about this process backwards. They overpay their taxes and then expect a refund. That’s a mistake for a variety of reasons, but it’s understandable.
Forced savings is for many the only way saving happens at all. But there are much better ways to force yourself to save. Those ways also happen to cut your tax bill automatically.
Here are the steps you should consider putting into place for this year and next to save big money on taxes:
Step No. 1: Build up cash immediately
If your goal is to save on your 2016 taxes, you need cash to do that. Halt all unplanned spending, such as dinners out or new clothes, and build up your short-term cash savings.
Step No. 2: Open or fund your 401(k)
If you have a job with a workplace retirement plan, such as a 401(k) or 403(b), ask the administrator about adding in a lump sump before your tax deadline. It might not be possible, so don’t get frustrated if the answer is no.
But check there first because it might qualify you for at least some of your annual company match. That’s free money.
Step No. 3: Open or fund your IRA
If your workplace plan won’t let you write a big check, go ahead and fund your IRA instead. You won’t get the matching money but you will get the tax break on 2016 if you fund it on time. The deadline is Tax Day, which this year is April 18.
The deductible contribution limits will vary by age, your 401(k) contributions and other factors, but every dollar you put in lowers your income for the previous year. That’s real tax savings.
Step No. 4: Put money into a health savings account
If you have a high deductible plan and you have exhausted your IRA and 401(k) options, check your health savings account limits. Chances are you can add to that account too, lowering your income that much more for 2016.
Step No. 5: Get ahead for next year
If you have 2016 squared away, walk back through this process for the coming tax year while it’s top of mind. Set up your 410(k) contributions by at least enough to get any company match and more if you can.
Do the same for your upcoming year HSA account. Your company should be able to make the contributions automatic. If you have kids in daycare, consider an automatic FSA contribution to cover those fees. That lowers your income, too.
Step No. 6: Adjust your withholding
If you up your automated contributions your taxable income for the year will drop. You should recalculate your withholding to make sure you don’t overpay taxes.
This can be tricky but there are plenty of online calculators and your HR manager might be able to help, too. The idea is to pay enough in taxes each paycheck without overpaying.
At the end of the year you want as little refund as possible and more paid into your retirement accounts instead. That lowers your taxes year in and year out, and a portion of those tax savings will head into your retirement plan, too.
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