Taxes are a burden to Americans across the board, and unfortunately, there’s no avoiding them completely. But there are strategies you can adopt to lower your tax burden — and you may want to adopt them soon.
In a recent Nationwide survey, 60% of Americans say they think their taxes will rise significantly within the next four years. Whether you share the same concerns or are more optimistic, here are a few things you can do to prepare for that possibility and lower your tax burden right now.
1. Max out tax-advantaged retirement plans
Once you retire, Social Security generally won’t pay you enough to cover all of your living expenses. Rather, you’ll need outside income to supplement those benefits, and that’s where retirement savings come in.
But that’s not the only reason to consistently sock money away in an IRA or 401(k) plan. If you fund one of these accounts, you could also lower your tax burden either immediately or in the future.
Traditional IRAs and 401(k)s are funded with pre-tax dollars, so the more money you put in, the more income you shield from the IRS. If you contribute $5,000 to either plan, for example, that’s $5,000 of income the IRS won’t tax you on — though you will be taxed on your withdrawals during retirement.
Roth IRAs and Roth 401(k)s work the opposite way — contributions aren’t tax-free, but withdrawals are. If you think your tax rate will be higher in retirement than it is right now, then a Roth savings account is a smart bet.
2. Hold investments in a non-retirement plan for at least a year and a day
Investments held in a tax-advantaged retirement plan like an IRA or 401(k) aren’t subject to the same capital gains taxes as those held in a regular brokerage account. If you sell investments in a traditional brokerage account at a profit, you’ll be liable for capital gains taxes the year you take in that profit. But the amount of those taxes will vary depending on how long you’ve held your investments.
Short-term capital gains on investments held a year or less are taxed the same way ordinary income is — at a higher level. On the other hand, long-term capital gains taxes, which apply to investments held for at least a year and a day, are taxed more favorably. Most people pay a 15% tax rate on long-term gains, while the country’s wealthiest pay 20%. As such, holding investments long enough to get into this tax category is smart.
President Biden is proposing to raise the rate on long-term capital gains substantially — to the point where they’d be taxed comparably to short-term gains. But his proposal only applies to people earning $1 million or more, which means it won’t impact most Americans if it gets passed. As such, holding investments for at least a year and a day before selling them is still a smart thing to do.
Taxes are a drag, and the idea of them going up may not sit well with you. The silver lining, however, is that there are simple steps you can take to reduce your tax burden — and save yourself a whole lot of money in the process.