3 simple ways to reduce your taxes next year
We all want lower taxes, right? There are some things you can do to reduce your taxes year after year, and you might be surprised at how much you can save. With that in mind, here are three ways you could save thousands of dollars on your taxes in 2016 and beyond.
Save for retirement
By far, the best way to lower your taxes is to save more for your retirement. Not only do you get a lower tax bill now, you’re also creating your own financial security in the process.
Saving money in tax-deferred retirement accounts such as a traditional IRA or 401(k) can reduce your taxable income by quite a bit. You could qualify for up to $5,500 in tax-deferred contributions to a traditional IRA for the 2016 tax year, and an additional $1,000 if you’re 50 or older.
401(k) limits are even more generous. You’re allowed to defer up to $18,000 into your employer’s 401(k) plan for 2016 ($24,000 if over 50), and this doesn’t include any matching contributions that come from your employer.
Just to illustrate this, let’s say you commit to saving $5,000 per year in a traditional IRA from now on. If you’re in the 25% tax bracket, this translates to $1,250 in tax savings. Plus, a steady investment plan like this can build a pretty impressive nest egg. Based on the S&P 500’s historical rate of return, $5,000 per year can grow to more than $300,000 after 20 years.
In addition, low- and moderate-income taxpayers may qualify for the Retirement Savings Contributions Credit, also known as the “Saver’s Credit.” This is worth up to 50% of your first $2,000 in retirement savings per year, depending on your marital status and income. In other words, if you qualify, the government will literally pay you to save money.
Buy a house
There are several tax breaks that come along with homeownership, and they can combine to save you a good chunk of money on your taxes. These include:
- Mortgage interest
- Mortgage insurance premiums
- Property taxes
- “Points” you pay to obtain a mortgage
The most widely known benefit is the mortgage interest deduction. If you itemize deductions on your tax return, you can write off the interest you pay on mortgage debt on a first and second home, on up to $1 million in original mortgage balances. In addition to the interest, you can also include any mortgage insurance premiums you’re required to pay.
Property taxes are also deductible, as are any points you paid to obtain the mortgage. When you add all of these things together, it can be a pretty nice tax break.
As an example, let’s say that you buy a $250,000 house and put a 20% down payment on a 30-year mortgage at 4% interest. According to a mortgage calculator, you’ll pay $7,936 in interest in the first year. And, we’ll assume your property taxes are about 1% of the home’s value, or $2,500. This combines to produce a $10,436 deduction — if you’re in the 25% tax bracket, this translates to a potential $2,609 in tax savings in your first year of homeownership.
Another great way to save on your taxes is to contribute to causes near and dear to you. The IRS lets itemizers deduct donations to qualified non-profit organizations and charities, including cash donations as well as property.
Keep in mind you’ll need to be able to document your donations, and the documentation requirements are stricter for higher-valued donations. For example, a simple receipt with the charity’s name is just fine for property valued at less than $250. However, if you donate say, a car or boat worth more than $5,000, a professional appraisal is required.
As a final tip on charitable donations, don’t forget to save your documentation for smaller donations throughout the year. If you hit the “donate $1.00” button when checking out at the grocery store, set that receipt aside. Or, if you give $20 to a group’s fundraiser car wash, make a note of it, and preferably donate with a check so there will be a record of it. You may be surprised at how these seemingly small donations can add up.
More benefits than just lower taxes
These three things can trim thousands of dollars off your tax bill, but the benefits don’t stop there. By aggressively saving and investing for retirement, you can help ensure your own financial security later in life. Buying a home can lock in your housing payment, while all of your rent-paying friends watch theirs increase every year. And finally, charitable giving can benefit organizations and people in need in infinite possible ways.
Motley Fool | USA TodayJohn Pharr CPA
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