May 15, 2023
How to Maximize Your Tax Savings This Year
By Chris Palabe, CFS®, AIF®
As Benjamin Franklin famously said, “In this world, nothing can be said to be certain, except death and taxes.” While we can’t avoid paying taxes, we can certainly take advantage of every opportunity to save some money. Although tax season is in the rearview mirror, don’t put tax planning on the back burner. Now it’s time to start thinking about how to maximize your tax savings for 2023. From taking advantage of deductions to exploring tax credits, there are plenty of ways to reduce your tax burden and keep more money in your pocket. So, grab your calculator and read on for my top 10 tax-planning strategies for the year ahead.
Maximize Your Retirement Contributions
Maximizing your retirement contributions is one of the best ways to minimize your tax liability. This is because retirement plans offer useful tax advantages that are not available if you were to simply put your money in a savings account. There are several accounts to consider, depending on your unique circumstances:
- 401(k), 403(b), and 457 Plans: These accounts allow you to contribute up to $22,500 annually for 2023 ($30,000 if over age 50). (1) Not only that, but contributions done pre-tax won’t show up as part of your annual income. This is a great way to defer taxes until your retirement years when you could potentially be in a lower tax bracket.
- Traditional IRA: Contributing to a traditional IRA is another way to reduce your tax liability if your income is within certain limits. (2) You can contribute up to $6,500 for 2023, (3) with a $1,000 catch-up contribution limit for those over age 50. Unlike the qualified retirement plans listed above, contributions to a traditional IRA can be made until the April 15th tax filing deadline.
- Roth IRA: This is an attractive savings vehicle for many reasons, including no required minimum distributions (RMDs), tax-free withdrawals after age 59½, and the ability to pass wealth tax-free to your heirs. The contribution limits are the same as traditional IRAs. However, Roth IRAs have income restrictions (4) and you may not be able to open an account outright if you are above certain limits.
Consider Roth Conversions
If you are outside of the income eligibility threshold for Roth IRAs but still want to take advantage of the Roth tax benefits, a Roth conversion could be the right strategy for you. It works by paying the income tax on your pre-tax traditional IRA and converting the funds to a Roth IRA.
You could also consider the mega backdoor Roth and backdoor Roth IRA strategies:
- Mega Backdoor Roth: With this strategy, you would convert a portion of your 401(k) plan to a Roth. This involves first maximizing the after-tax, non-Roth contributions ($44,500 in 2023) (5) in your plan, then rolling it over to either a Roth 401(k) or your Roth IRA. With the mega backdoor Roth, you convert a portion of your 401(k) plan to Roth dollars.
- Backdoor Roth IRA: In this case, you would make an after-tax (non-deductible) contribution to a traditional IRA. You then immediately convert the funds to a Roth IRA to prevent any earnings from accumulating. This strategy makes sense if you don’t already have an IRA set up yet.
All three Roth conversion strategies will allow the contributions to grow completely tax-free and allow you to avoid future RMDs, which is helpful if you expect to be in a higher tax bracket in the future.
Contribute to a Health Savings Account
An efficient but underutilized way to maximize your savings and minimize your taxes is to contribute to a health savings account (HSA). HSAs offer triple tax savings: contributions are tax-deductible, earnings grow tax-free, and you can withdraw the funds tax-free to pay for medical expenses. Unused funds roll over each year and will essentially become an IRA at age 65, at which point you can withdraw funds penalty-free for non-medical expenses. You must be enrolled in a high-deductible health plan in order to qualify for an HSA.
HSAs can be a great tax-management tool if you are able to pay medical expenses out of pocket and leave the HSA funds to grow. The 2023 contribution limits for HSAs are $3,850 for individuals and $7,750 for families. (6) If you are 55 or older, you may also be able to make catch-up contributions of $1,000 per year. You have until April 15th for your contributions to count for the previous year’s tax return.
Contribute to a Donor-Advised Fund
If you itemize your tax deductions because of charitable contributions, you may want to consider investing in a donor-advised fund (DAF). You can contribute a lump sum all at once and then distribute those funds to various charities over several years. With this strategy, you can itemize deductions when you make the initial contribution and then take the standard deduction in the following years, allowing you to make the most out of your donation tax-wise.
You can also donate appreciated stock, which can further maximize your tax savings. By donating the appreciated position, you avoid paying the capital gain tax that would have been due upon sale of the stock and you are effectively donating more to your charities of choice than if you had sold the stock and donated the proceeds.
Make a Qualified Charitable Donation
If you own a qualified retirement account and are at least 70½, you can use a qualified charitable distribution (QCD) to receive a tax benefit for your charitable giving. Since this is an above-the-line deduction, it can be used in conjunction with other charitable tax strategies. A QCD is a distribution made from your retirement account directly to your charity of choice. It can also count toward your RMD when you turn age 73, but unlike RMDs, it won’t count toward your taxable income. Individuals can donate up to $100,000 in QCDs per year, (7) which means a married couple can contribute a combined amount of $200,000!
Utilize Tax-Loss Harvesting
Tax-loss harvesting involves selling investments at a loss in order to offset the gains in your portfolio. By realizing a capital loss, you are able to counterbalance the taxes owed on capital gains. The investments that are sold are usually replaced with similar securities in order to maintain the desired asset allocation and expected return.
With the extreme market volatility of 2022, chances are you have some capital losses that can be utilized. For example, if you are expecting a large capital gain this year, sell an underperforming stock and harvest the losses to offset your gain.
Tax-loss harvesting can also be used to reduce your ordinary income tax liability if capital losses exceed capital gains. In this case, up to $3,000 can be deducted from your income, and capital losses in excess of this amount can be carried forward to later tax years.
Understand Long-Term vs. Short-Term Capital Gains
Understanding the tax implications of long-term versus short-term capital gains can go a long way in reducing your tax liability. For instance, in 2023 a married taxpayer will pay 0% capital gains tax on their long-term capital gains if their taxable income falls below $89,250. (8) That rate jumps to 15% and 20% for taxable incomes that exceed $89,250 and $553,850, respectively. Understanding where you fall on the tax table is an important part of minimizing your liability.
Gains that are short term in nature (held less than one year) will be taxed at your marginal tax bracket, which could be up to 37%! Knowing both the nature of your gain, as well as your tax bracket, is crucial information if you want to minimize your tax liability.
Take a Qualified Business Income Deduction
Business owners involved in partnerships, S corporations, or sole proprietorships can take a qualified business income deduction (QBID) to help reduce taxable income and maximize tax savings. This allows for a maximum deduction of 20% of qualified business income, but limits apply if your taxable income exceeds a certain threshold. (9) To qualify for this deduction, consider reducing or deferring income so that you can remain below the phase out threshold. A great way to do this is to maximize your retirement contributions to tax-advantaged accounts (as discussed in point #1).
Consider Estate Tax-Planning Techniques
Estate tax-planning techniques can also be an effective way to reduce current-year tax liability. For 2023, the lifetime exemption for assets that can be given gift-tax free is $12.92 million for individuals and $25.84 for married couples. (10)
The annual gift tax exclusion has also been increased to $17,000 per recipient in 2023, up from $16,000 in 2022. This is the annual amount taxpayers can give tax-free without using any of the above-mentioned lifetime exemption. Not only that, but the annual exclusion applies on a per-person basis, so each taxpayer can give $17,000 (up from $16,000 in 2022) per person to any number of people per year.
Though gifting and other estate tax-planning strategies are not tax-deductible, they can help to significantly reduce your taxable estate over time.
Make Sure Your Advisory Team Is Working Together
Beyond consulting with a tax professional, you’ll want to be sure your entire financial team is working together to provide cohesive oversight and guidance. This should include professionals like CPAs, financial advisors, investment advisors, and estate attorneys. Your finances don’t exist in a bubble and so neither will your tax-minimization strategies. When your advisory team works together, strategies are easier to identify and execute, and proactive tax solutions become much easier to implement, reducing stress and your tax bill.
We Can Help You Save
Tax planning doesn’t need to be a daunting or overwhelming task, especially when you collaborate with an advisor who possesses extensive expertise in tax matters. At Palabe Wealth, we can guide you through the complexities and beyond. If you’re eager to reduce your tax burden and enhance your finances, we welcome you to get in touch with us. Schedule a 15-minute introductory phone call or call us at 847-249-6600 to learn if we are the right fit for your financial goals.
About Chris
Chris Palabe is the founder and CEO of Palabe Wealth, a financial services firm providing retirement plan strategies for businesses and individuals. For 25 years, Chris has been serving his clients with customized plans and a boutique approach. He started his firm because of his passion for making a difference in others’ lives and a genuine desire to build long-term relationships with his clients so they can seek to achieve their ideal retirement and manage risk. Chris is a Certified Fund Specialist® (CFS®) and Accredited Investment Fiduciary® (AIF®) professional and has a degree from Université Denis Diderot (Paris VII). When he’s not working, you can usually find him riding horses and competing in dressage at a national level. He also loves reading, watching movies, and eating out. To learn more about Chris, connect with him on LinkedIn.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Contributions to a traditional IRA may be tax-deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59½ may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
No strategy assures success or protects against loss.
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(1) https://www.investopedia.com/retirement/401k-contribution-limits/
(3) https://www.nerdwallet.com/article/investing/ira-contribution-limits
(5) https://www.investopedia.com/retirement/401k-contribution-limits/
(7) https://www.fidelitycharitable.org/guidance/philanthropy/qualified-charitable-distribution.html
(8) https://www.kiplinger.com/taxes/capital-gains-tax/602224/capital-gains-tax-rates
(9) https://www.nerdwallet.com/article/taxes/qualified-business-income-deduction
Chris Palabe, CFS, AIF®
Chris Palabe is the CEO and a Financial Advisor at Palabe Wealth, a firm that provides exceptional expertise in the Financial Planning space. For over 25 years, he has cultivated a deep understanding of the complexities of wealth management and retirement planning, making him a valued advisor to both Plan Sponsors of 401(k) plans and Individual Investors.
Holding esteemed designations such as Certified Fund Specialist (CFS) and Accredited Investment Fiduciary (AIF), Chris showcases his commitment to upholding the highest standards of investment advice and fiduciary responsibility in his advisory relationships. These designations are a testament to his knowledge and dedication to providing clients with sophisticated and ethical financial guidance.
He holds his Series 6, 7, 63, and 65 licenses through LPL Financial, which qualify him to offer a broad range of financial products and services.
Chris’s distinguished career is characterized by his unwavering commitment to his clients' financial well-being. He focuses on crafting tailored strategies that aim to optimize retirement outcomes and financial independence. He continually strives to help the individuals he works with on their path towards financial success.
Over the years Chris has refined a consistent, strategic investment philosophy supported by a significant body of academic research. He believes that a widely diversified portfolio of investments tailored to each client’s unique risk tolerance and financial goals is the key to their financial success.
Beyond his professional achievements, Chris has a profound passion for dressage, a highly skilled form of horse riding performed in exhibition and competition. This discipline requires a remarkable level of dedication, precision, and harmony between rider and horse, qualities that mirror his approach to financial planning.
