The best way to reduce your taxes is to reduce your income. Look at it from the perspective of the government and what they see as taxes. Here are some known types of tax-exempt income and strategies.
With tax season just around the corner, who doesn’t want more ways to pay fewer taxes?
401K contributions
The easiest way to reduce taxable income is putting money away for a 401k. In general, you’ll owe taxes on everything you make as soon as the money goes thru the door.
With the 401K, the IRS will let you contribute a sizable amount of your paycheck first without being taxed. You will be charged taxes on whatever is left.
The idea here is, you’ll be able to reduce your income because you’ll be paying taxes in much smaller amount.
Save with tax free earnings.
You can take a visual of it like this:
Salary- $5,000/month
401K- -$500 contribution
Lowers your taxable income to $4500
With a tax rate of 40%, your tax liability will be $1800 vs. $2000 on your $5000 salary.
That extra $200 will be going to your retirement and it earns compounding interest.
SEP IRA for self-employed folks
If your company does not offer 401(k) or you are self-employed, SEP IRA is the best avenue for you.
Health Savings Account (HSA)
You can look at this like 401k but for medical expenses. Any contributions that you make for it immediately reduces your taxable income.
Since this is primarily for health related expenses with tax free money.
Also, HSA’s you don’t need to wait for retirement to spend it.
That means you can use it for your contact lenses, massages, acupuncture visits, asthma treatments etc.
Typically HSAs are allowed for people that has health insurance plans that has very low monthly premiums but higher out of pocket expenses.
Having an HSA is beneficial if your pretty healthy and would like to take advantage of tax-free money that covers your health expense.
Municipal bonds
These are bonds issued by local governments to fund things like infrastructure, water project, a new bridge or any projects that a city needs to run well.
You can open munis through a municipal bond funds. Its a bond or group of funds from different municipalities.
This is good because it helps you diversify and spread out your risk. Short-term municipal bonds are a safe way to park your cash while earning interest.
1031 Exchange
If you own rental property or want to own rental property in the future, this one can save you tons on taxes.
Real Estate tends to go up in value, but if you ever to sell, you’ll be on the hook for major taxes on capital gains.
Capital gains could be as high as 20%, that’s a big chunk.
With 1031 exchanges, you can get away with never paying taxes on any of your real estate transactions.
In a 1031 exchange you pay 0% taxes on the capital gains that you could be liable for when you sell your real estate investment.
There are some basic rules to comply with.
– You need to roll over your supposedly gains to an equal or more valued property.
It’s basically a tax break by the government to help you grow your real estate portfolio.
Normally when you sell your investment property, you’ll pay full capital gains from the profits you’d made.
Without a 1031 exchange, you’ll have 20% less buying power on your next property.
Real estate investors use this tactic to reduce their taxes and scale their wealth.
ROTH IRAs
This is another way to reduce your taxes on your investment.
Anything you buy inside of a ROTH IRA , you’ll never pay taxes on.
We are talking about:
-stocks
-bonds
-assets
These investments can grow tax free until you retire. When you retire, any income get or withdraw from your ROTH are tax-free as well.
The caveat with ROTH is your contributions are not tax-free in the present but you get the tax benefits on the backend when you retire.
Reduce your taxes by combining strategies
The best way to get the full benefit of these investments is to combine the approach and be consistent with your contributions.
If you plan to buy some stocks or bonds make sure that you buy inside of the ROTH, SEP or 401Ks and maximize the gains.
Making sure that you are doing it in a taxed advantaged account before purchasing it in a brokerage account which is fully taxable.
