Tax Mitigation Strategies
Contribute More to your Pre-Tax Qualified Accounts
With the year almost over, there are plenty of action items to tackle to improve your finances. Specifically, you have until the end of the year to “max out” contributions to tax qualified accounts like your TSP 2022. IRA contributions can be made up until you file your 2022 taxes. If you’re looking to sock money away, we’d recommend prioritizing these accounts as they have annual limits. Start with your employer matched 401(k), the Thrift Savings Plan (TSP). The contributions you make to your Traditional, or pre-tax, TSP will lower your Adjusted Gross Income (AGI) reducing your taxable income and the income taxes you pay today. 401(k)s and TSPs, like all tax-qualified accounts, place maximums on the amounts you can contribute each year. For 2022, the annual contribution limit is $20,500 for people under the age of 50 and $27,000 for those over age 50.¹
After maxing out your employer sponsored retirement account you should consider contributing to an Individual Retirement Account (IRA.) IRAs are different from 401(k)s in that they are individual accounts, meaning you open them with firms like PARCO, and you completely control what investments you pick. Depending on your income, you may be able to deduct some IRA contributions on your tax return. Like a 401(k), monies in IRA’s will grow tax deferred—and you won’t pay income tax until you take it out.² It is important to note that IRA’s have a lower contribution limit. Your annual contributions limits are $6,000 with a $1,000 catch if you’re older than 50.¹
What about if you’re in no need to reduce your taxable income and actually find yourself in a lower tax bracket? This can be the case for a gap in employment, post retirement, or some other life event. In a situation like this, you may want to convert some of these traditional accounts into “tax-free” funds known as Roth IRA’s. Doing so will actually count as taxable income for the year. Any Roth conversions must be completed by 12/31/2022 to count for this taxable year. Be sure to speak to one of our tax experts before you continue or check out our Webinar on Roth Conversions by clicking on the link below!
Use your Investment Losses to Lower your Tax Burden on Non Qualified accounts
This year was tough for many investments. The silver lining is that you can use the losses of these investments to offset your tax burdens for the year. This tax mitigation strategy, often referred to as tax-loss harvesting, can help offset capital gains with capital losses.
Tax-loss harvesting generally works like this:³
You sell an investment at a loss of $3,000.
You sell shares in another investment with a gain of $3,000.
These two losses offset each other, since you have a loss on one investment you don’t have to pay a capital gain tax on the other.
You can use that loss to reduce your taxable capital gains and potentially offset up to $3,000 of your ordinary income.
Finally, you reinvest the money from the sale into a different security that meets your investment needs and asset-allocation strategy.
Optimize Your Personal Finances
There are other strategies you can implement as the year ends to improve your financial position. As the year comes to a close, now is a great opportunity to look over your spending for the year, and see if there are any subscriptions or things in your budget which you may not be using. Canceling a few unnecessary things can add up to real savings over the course of the year. You’ll want to start by focusing on what your net income will be. With the COLA’s that have been tagged onto many salaries, it’s time to update how that affects your personal finances. Your net income is your total wages or salary minus deductions for taxes and employer-provided programs such as your CSRS or FERS pension, TSP contributions, and your Federal Employees Health Benefits (FEHB).
Once you know the amount that’s coming in for you and family, it’s imperative to know how that money is being spent. Getting into the weeds of your expenses is a huge benefit because it shines a light on things that are not necessary, and potentially creates pockets of saving opportunities. Start by looking at fixed-expenses such as utilities, insurance, or mortgage expenses. Review your service bills, such as wireless and cable, and see if you can get a lower rate, and look for savings by bundling your insurance policies with a single carrier.³ Now direct your optimization lens to variable expenses such as entertainment, groceries, gas, etc. Can you imagine the amount of money saved if we were to fix the numerous unnecessary leaks depleting our bank accounts? Do you know how many subscriptions you and your family are paying for? It truly pays to be informed.
Knock out High Interest Debt
Many people find themselves lost not knowing where to start when it comes to the best path of becoming debt free. When it comes to debt, the most important factor is the interest rate, essentially the cost of money; Things like credit cards, auto-loans, or even personal loans tend to have higher interest rates, which means they should be the first on your list to pay off. The average credit card APR in 2021 was 16.45% and increased to 18.43% in Q3 of 2022.⁴ This debt compounds and can grow quickly, especially if you’re not actually paying it down each month. By focusing on the highest interest debt and paying down interest plus principal each month, the interest won’t have time to compound and you’ll start saving money and avoiding the cycle of debt.⁵
A powerful tool available to feds for resetting your finances, especially if you find yourself with a lot of high interest debt, is a TSP loan. You can borrow from your own 401(k) even before the age of 59.5, with no tax penalty! The icing on the cake is that the interest rate you pay on TSP loans is the G-Fund rate, and you pay it back to yourself. Be sure to consult one of our financial experts before proceeding forward.
¹IRS. (n.d.). Retirement topics - 401(k) and profit-sharing plan contribution limits. Internal Revenue Service. Retrieved December 8, 2022, from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution
²TIAA. (n.d.). Tips that can help reduce your income taxes. TIAA. Retrieved December 8, 2022, from https://www.tiaa.org/public/learn/personal-finance-101/how-to-reduce-taxable-income
³Schwab.com. (n.d.). How to cut your tax bill with tax-loss harvesting. Schwab Brokerage. Retrieved December 8, 2022, from https://www.schwab.com/learn/story/how-to-cut-your-tax-bill-with-tax-loss-harvesting
⁴Federal Government . (n.d.). Board of governors of the Federal Reserve System. The Fed - Consumer Credit - G.19. Retrieved December 8, 2022, from https://www.federalreserve.gov/releases/g19/current/default.htm
⁵Joly, B. (2021, November 22). Why should you pay off high-interest debt first? Credello. Retrieved December 8, 2022, from https://www.credello.com/debt/should-you-pay-off-high-interest-debt-first/