When it comes to accumulating wealth and building for the future, it is not how much you make but how much you get to keep. Taxes can take a big bite out of your savings, and making up for that shortfall could put you further and further behind. If you want to accumulate serious money and enjoy a financially stable retirement, you need to take taxes into consideration. Taking advantage of current tax law and using legal ways to reduce your taxable income can put you one step ahead and make it easier to save more money in the future. Here are five smart ways to reduce your taxable income while building wealth for the future.
#1. Up Your 401(k) Contribution
Contributing more to your workplace retirement plan is probably the easiest way to reduce your taxable income. That is because every dollar you contribute to your 401(k) is deducted directly from your taxable income.
If you earn $50,000 a year and contribute 6% of your income to the 401(k) plan, that $3,000 comes straight off your taxable income, reducing it to just $47,000. Raise that contribution amount to 10%, and your taxable income falls to just $45,000 and so on. Best of all, that money can grow and accumulate throughout your working years, creating a nice nest egg you can live on later.
#2. Contribute to an IRA
If you have earned income, you may also be able to contribute to an IRA. Putting money aside in a traditional IRA gives you an up-front tax break, reducing your taxable income and reducing your tax bill.
For 2016, you can contribute up to $5,500 to a traditional IRA, and every dollar you put in lowers your taxable income by that amount. If you are 50 or older, you can kick in an extra $1,000, bringing the total to $6,500.
You may even be able to contribute on behalf of a non-working spouse, so if your partner stays home to raise the kids, you could still lower your taxable household income. The rules can get a bit complex, so check with a tax preparer, but if you are eligible, a spousal IRA could lower your taxable income even further.
#3. Cut Your Losers Loose
If you invest in individual stocks, you probably have a few that have not performed as well as you expected. Instead of leaving them in your portfolio, sell them and let them lower your taxable income.
You can write stock losses off against any gains you have elsewhere, reducing the amount of capital gains taxes you have to pay. If your losses are bigger than your reported gains, you can use them to reduce your taxable income by as much as $3,000. Even better, excess losses roll over, so you could take the same deduction next year.
#4. Set Money Aside in a Flexible Spending Account
A flexible spending account, or FSA, allows you to pay for certain healthcare expenses with pre-tax dollars, lowering your taxable income in the process. Many employers offer flexible spending accounts to their employees, so chances are your boss does too.
You will have to budget the money carefully, since the bulk must be spent in the year it was allocated. You can roll over a small amount from year to year, but check with your human resources department for specific details.
#5. Track Your Job Hunting Expenses
If you were out of a job for part of the year, you may be able to write off the cost of finding a new job. Many job hunters fail to analyze their expenses, and they may not realize how expensive it is to be looking for work.
Keep track of every expense you accrue while looking for a job, from the cost of paper and postage to the money you spend on gas and automotive maintenance. Add it all up and use it to reduce your taxable income.
The lower your taxable income, the lower your tax bill will be. You do not have to cheat on your taxes or lie about your income to sharply reduce your tax bill; the IRS has provided many ways to legitimately lower your taxable income, so take advantage of their largesse.