11 of My Favorite Tax Saving Strategies
I hope this post doesn’t come across as unpatriotic. I really do love being an American and feel incredibly blessed to live in the greatest country on earth.
But admittedly, I don’t enjoy paying taxes.
I think if most of us are honest about our duty as Americans, we’ll admit that taxes are necessary to provide commonly shared infrastructure and services that make life better for all of us.
But I think we’d also admit that we’re not always thrilled about the way the government uses our tax dollars and we would prefer to limit our tax liability as much as legally possible.
Heck, even the Supreme Court agrees with that mindset.
In that spirit, I thought it might be interesting to share several of my favorite tax saving strategies.
To be clear, the level of benefit these produce for you will depend on your personal tax situation and the state you live in.
Some of these may not help you at all and there may be some missing that could be particularly beneficial to you.
Also, there is a lot of information here, but it really could be worth loads of money in tax savings. Hang in there because I think it will be worth your while.
With all of this in mind, here they are my favorite tax strategies no particular order.
1) Tax-Advantaged Retirement Accounts
This first idea is one I will refer to often in this post.
Tax-advantaged retirement accounts are accounts that provide some sort of tax incentive in order to incentivize saving and investing for retirement.
You are probably familiar with most of these:
Normally, these plans provide a tax deduction either on contributions or they allow you to make tax-free withdrawals after you reach a certain age (typically 59.5).
This article will be long enough as it is, so I’ll spare you a lengthy explanation and just hope you trust me when I say there is indeed a considerable long-term benefit available for those who use these plans. If you want more detail, this post about ranking retirement plans has a pretty good overview.
For the most part, these plans either provide you with tax-deferred earnings (which earn more than after-tax earnings) or the earnings grow completely tax-free after you make after-tax contributions.
The extent of the benefit will depend on your state and federal tax rates when you make contributions and withdrawals, but on average these accounts should save you around 20% or more of the value of your total account balance.
Each of these accounts come with varying levels of contribution limits, sometimes based on your adjusted gross income. Here are those limits for 2024:
These accounts are widely available to almost all Americans with income and are capable of producing an extensive benefit for those who are wise enough to take advantage of them.
As we walk through the other tax efficient strategies you will see these account come up multiple times.
2) Health Savings Accounts
Health Savings Accounts were primarily created to incentivize people to migrate toward High-Deductible Health Plans (HDHP) which shift the burden or cost for smaller medical events to the insured instead of the insurance company.
An HDHP is exactly as the name describes, a health insurance plan with a higher deductible. This means insured parties pay for their medical expenses out of pocket until they reach these higher deductibles.
The idea is if people have “skin in the game” they are more likely to make thoughtful decisions about their health and medical care.
To assist with the potential costs of HDHPs, Health Savings Accounts were created allowing account owners to put away thousands of pre-tax dollars each year which can potentially be invested in a wide range of securities.
If the withdrawals from an HSA are used for a qualified medical expense, the contributions, earnings, and withdrawals or payments from the account are completely tax-free.
That makes HSAs potentially more valuable than the retirement accounts we covered previously.
Additionally, if you contribute to an HSA through payroll deduction, your contributions avoid social security and Medicare taxes as well avoiding another 7.65% of taxes you would otherwise have to pay.
There are limits for annual contributions to an HSA which are in the table below. The good news is there is no limitation on how high your HSA can grow.
Since the typical American will spend well over $300,000 on medical expenses between the age of 65 and the time they pass away, HSAs can be a very effective tax-saving tool.
There are a couple of other HSA features and rules to keep in mind.
The first one is any withdrawals made from an HSA for any reason other than a qualified medical expense before age 65 are subject to income taxes and a 20% withdrawal penalty.
That is one of the heftiest withdrawal penalties the IRS levies (RMD penalties are the only ones I know of that are higher at 25%).
However, when you do turn 65 you are allowed to withdraw funds from your HSA for any reason. You won’t owe any penalties for these withdrawals, but you will owe income tax effectively making the HSA similar to other tax-deferred retirement accounts.
Finally, HSAs are one of the least estate-friendly retirement accounts because inherited HSAs must be completely liquidated in the year they are inherited making them fully taxable to the account beneficiaries.
If the balance isn’t very large, this isn’t a big deal. But if you leave a large sum of money to an heir who already has a relatively high marginal tax rate, much of the balance will be claimed by Uncle Sam.
The one, very notable exception to this is spouses. If you pass away and leave an HSA to your spouse, they get to use it as if it were their own account until they pass away.
3) Own a Business
We could follow this third benefit down some very deep and complicated rabbit holes. For the sake of brevity, I will try to hit some of the more popular tax benefits of owning your own business at a high level.
I should also mention that even though there are many tax benefits available to business owners, there are also many tax burdens placed on them as well. If you have a small business or plan to open one, these may be of use to you, but I would not recommend inventing a business primarily for the sake of taking advantage of these strategies.
It’s Deductible
The first one I’ll cover is deductions.
Expenses incurred for the sake of starting, operating, and even closing a business are tax-deductible.
This could include anything from meals and entertainment to cars, electronics, travel, and professional services like accounting, financial, or legal help.
As a small example, I started MartinMoney.com and our YouTube channel as a hobby, but now operate it as a small business.
The expenses I previously incurred for software, licensing, domain fees, electronic equipment, etc. are now tax-deductible.
Since I was in the 24% marginal tax bracket last year, the expenses that were eligible for a deduction through my business effectively came at a 24% discount.
Granted, it isn’t much for my small business, but $240 saved for every $1,000 spent is a strong savings rate.
Solo 401(k)s
Another intriguing benefit is the Solo 401(k).
Solo 401(k) plans work similarly to regular 401(k)s with a few notable exceptions.
In 2024, you can contribute up to $23,000 to a Solo 401(k) ($30,500 if 50+) as the employee and employer + employee contributions can reach all the way to $69,000 ($76,5000 if 50+).
If you own a small business and you and your spouse are the only employees, you can contribute both as the employee and as the employer to a Solo 401(k).
A fun feature of Solo 401(k)s is that you can make these contributions even if you participate in an employer-sponsored 401(k) plan at another job.
You only get a cumulative annual employee contribution of $23,000 for all 401(k) plans, but you can make the full $69,000 ($76,500 if 50+) contribution as the employer in your Solo 401(k).
If your spouse works in the business, they are eligible to participate as well.
So, if your small business does well enough, that gives you a ton of room for stashing away tax-advantaged retirement savings.
Do note that if your Solo 401(k) balance reaches $250,000, you’ll need to submit form 5500-EZ with your annual tax return. This is a reporting requirement only, but it isn’t one you want to forget.
Others
Here are a few other tax benefits of owning a business:
- Deductions for interest, marketing, insurance, mileage, moving, rent, internet, etc.
- Depreciation for certain assets (especially helpful if you have rental property)
- Square footage at your home dedicated to your small business
4) Income From Investments
Warren Buffet was once famously quoted for commenting that his secretary pays more in taxes than he does each year.
Now to be fair, Warren phrased this rather poorly to make a point.
In the context of the conversation, Mr. Buffet meant that his secretary pays higher taxes as a percentage of income than he does.
While this may be less shocking, it may still entice one to wonder how this is possible.
The answer lies in the differences between long-term capital gains tax rates and the tax rates the IRS levies on income in the United States.
The bottom line is long-term capital gains and qualified dividends are taxed at lower rates than income. This means you get to keep more of the money you make from investments than you do from your labor.
I’m not going to argue the merits of that approach, but I do want you to be aware that the money you make from your investments can produce a tax benefit.
This is how extremely wealthy people manage to pay as little tax as they do. Well, that, and the fact that they pay a bunch of very smart people to shield their money from taxes.
If this upsets you, feel free to write your congressman, but in the meantime, I would also seek to take advantage of this same wrinkle in the tax code.
As an example, let’s assume you’re 63 years old, retired, and you want to liquidate $50,000 of your investments to buy a boat.
Let’s assume your options are to make the withdrawal from your IRA or to sell assets you’ve held for years in your taxable brokerage account to access the funds.
We’ll further assume that you already pull your living income from the IRA which puts you in the 22% tax bracket and the assets you’d sell from the taxable brokerage are 50% capital gains.
If you pull the $50k from your IRA, you’ll owe another $11,000 in income tax ($50k x 22%).
If you sell the assets in the brokerage, you’ll only owe $3,750 in capital gains taxes because only half of the assets sold were gains and they are taxed at 15% instead of 22% ($25k x 15%).
Granted, the cost basis in your taxable brokerage was almost certainly taxed as income before you transferred those funds into the account, but you’re still better off realizing the income as a capital gain instead of income.
5) Tax Gain or Loss Harvesting
Continuing along the thread of tax savings through investing, tax gain, and loss harvesting are effective ways to save some money.
Tax Loss Harvesting is a strategy that can be used during a period of significant depreciation in the value of an asset, usually a stock, mutual fund, or ETF.
Since losses in the value of invested assets are deductible, intentionally realizing a capital loss provides one with an instant tax deduction.
The problem with selling to trigger a loss is 1) it’s a form of market timing, and 2) it could potentially sacrifice your asset allocation for the sake of tax savings. This isn’t a wise trade.
To avoid these two issues, you should immediately rebuy a similar asset that isn’t “substantially identical” to the one you just sold at a loss.
You can’t rebuy a “substantially identical” asset for at least 30 days, plus 1 after the sale of the asset you sold at a loss because this will negate the deductibility of the loss under the IRS’ wash sale rule.
I won’t attempt to define substantially identical here as I am not a tax professional and, as far as I know, the IRS hasn’t defined it either.
What I will say is that when I have tax loss harvested in the past, I elect to rebuy an asset for which I can easily explain how it is different than the one I sold.
For example, I have sold an S&P 500 ETF at a loss and rebought a Large-Cap Index Fund immediately after.
Thirty-one or more days later, I may sell the Large-Cap Index fund and move back to the S&P 500 ETF if I so choose.
I also have negated a capital loss by forgetting that I had just sold the asset a few weeks earlier. Bummer.
The good news is my brokerage caught the wash sale and my 1099 was drafted to account for this at the end of the year.
There isn’t a penalty for a wash sale unless you attempt to take the deduction anyway, so don’t fret if you forget and trigger a wash sale.
Capital losses can be used to offset up to $3,000 of income each tax year and any excess losses can be carried over indefinitely. If you have carryover losses, be sure to record them on the IRS’ Capital Loss Carryover Worksheet (scroll down to “Specific Instructions”).
Capital losses can be used to offset an unlimited amount of capital gains which will be better explained as we discuss tax gain harvesting.
Just like we use tax loss harvesting to trigger a tax deduction at a strategically advantageous time, we can use tax gain harvesting to realize gains while they’ll be taxed at low rates or to offset those gains using tax losses from earlier in the year or previous years.
As an example, let’s assume that you sold a stock at a $10,000 loss at the beginning of the year.
Toward the end of the year, the stock you bought to replace the one you sold at a loss has now realized a $5,000 gain.
So, in order to “harvest” this gain completely tax free, you decide to sell it and use your losses from earlier in the year to avoid any taxes.
One feature of harvesting gains is there is no wash sale rule, so you can immediately repurchase the security you sold for a free step up in tax basis or you can buy a different one.
While it’s great that you’ve spared $5,000 of gains from taxes, you still have $5,000 left to claim.
Well, if you don’t have any other assets that you can use for gain harvesting, you can use $3,000 of the remaining losses to offset taxable income.
The remaining $2,000 in losses can be carried forward to future tax years indefinitely.
There are some long-term tax strategies for loss harvesting, but I prefer to use them as soon as I can so I don’t have to keep up with them forever and the time value of money deteriorates their value the longer they sit unused.
Also, it may seem obvious, but you can only tax harvest in taxable accounts. These strategies are kind of pointless in a tax-deferred, Roth, or Health Savings Account.
Finally, you can harvest both short and long-term gains and losses, but losses will first be used to offset gains of the same type. The remaining losses can then be used to offset gains of different types.
6) Donor-Advised Funds
There are many ways to receive tax benefits from charitable gifts. The first one we’ll discuss is Donor-Advised Funds.
If your tax situation is such that you don’t itemize, (meaning the standard deduction is more valuable than the value of your itemized deductions, including donations) you can use donor-advised funds to combine several years’ worth of donations into one year, making it beneficial to itemize for one single year while still making donations to charity at any time.
So, let’s say you file as single and your annual standard deduction is $13,850. You also enjoy making annual gifts of $8,000 to charity, but when combined with other deductions it still doesn’t make sense for you to itemize.
If you use a donor-advised fund, you can contribute the equivalent of three years of donations in one tax year, providing you with a $24,000 deduction.
Since you can direct the timing of donations from your DAF, this allows you to take advantage of your gifts for one big deduction in a single tax year while still being able to take advantage of the standard deduction in other years.
And the benefits are not limited to taxpayers who don’t typically itemize. You could use a DAF to offset a major influx in income in a given tax year or to take advantage of standard deductions that are at an all-time high.
Donor Advised Funds can be set up through all the major brokerages and are typically easy to use. Simply fund the account and you get a deduction.
Keep in mind, however, that contributions to a DAF are irrevocable. You can’t get them back out of the DAF if you change your mind.
Also, deductions for donations are limited to 60% of your adjusted gross income for cash gifts (50% if placed in a DAF) and 30% of your AGI for appreciated non-cash assets like stocks.
7) Donating Appreciated Stock
Another popular way to use taxable brokerage accounts is to donate appreciated stock or funds directly from the account to a charity of choice.
I do this myself and saved around $600 in 2023 alone.
As we’ve already covered, the sale of an appreciated asset triggers a tax on any capital gains that are realized from that sale.
If you donate the asset instead, the value of those donations (basis and gains) is all tax-deductible.
You might be thinking, “Gee, that’s great, but it’s also deductible if I just write a check to the charity.”
That is very true, but if you repurchase the stock you just donated at the same value you donated you now have the same amount of stock with zero unrealized gains and you still get the same deduction.
In other words, donating stocks provides a path to a free step up in the tax basis of the stocks meaning you avoid all the capital gains tax without any material change to your portfolio’s value or asset allocation.
For example, let’s assume you donate $1,000 of ABC stock to charity and $200 is capital gains.
If you donate the stock and immediately rebuy it, you get the same $1,000 of ABC stock, a $1,000 tax deduction, and your tax basis for the stock is now $1,000 instead of $800.
The net result is the capital gains taxes saved on $200.
Of course, this is also an effective way to rebalance your asset allocation if you want to donate an asset that you’re over-allocated to and rebuy one for which you have an under-allocation.
8) Qualified Charitable Distributions
Finally, if you are at the point in life where the IRS is forcing you to remove unneeded income from your retirement accounts through Required Minimum Distributions (RMDs) you can donate assets from your retirement accounts to satisfy those RMDs.
They are called Qualified Charitable Distributions (QCDs) and they are quite handy if you don’t need your RMDs for living expenses and are charitably inclined.
To be clear, there is no tax deduction for QCDs, but they do allow you to avoid paying income tax on income you don’t really need while benefiting a charity.
You can also use QCDs to reduce your retirement account balances that are subject to RMDs, effectively reducing future tax liability.
QCDs are limited to $105,000 annually per taxpayer, so if you’re married your spouse can also make a QCD of up to $105,000 each year.
Also, you have to be at least 70.5 years old to begin making QCDs, even though RMD age is now 73 or 75 depending on when you were born.
9) Roth Conversions
Continuing on the theme of Required Minimum Distributions, you can use Roth Conversions to limit their bite.
I’ve already mentioned that RMDs begin at age 73 or 75 depending on whether you were born before 1960 or during and after 1960.
Meanwhile, the average American retires around age 65, and odds are if you don’t need to take money out of your tax-deferred accounts you have enough to retire even earlier than that.
So, if this describes you and you expect RMDs to be an inconvenience, you may have several years to convert those dollars to a Roth IRA providing a path to potentially avoiding RMDs altogether.
Typically, people use the years between their retirement from full-time work and RMD age to slowly convert tax-deferred assets to Roth at a tax-efficient pace.
Since you won’t have full-time, or maybe any, working income, you should have a much higher degree of control over how much you remove each year from retirement accounts, meaning you effectively control your tax rate.
For example, let’s assume you’re 62, retired, and you primarily live on the assets in your savings or taxable brokerage account. As a result, your marginal federal tax rate is 12%.
Well, since conversions from a tax-deferred account to a Roth IRA are taxable, you can convert a sum that takes you to the top of the 12% bracket and pay 12% federal tax instead of a higher rate when you reach RMD age.
Or maybe you want to convert all the way to the top of the 22% or 24% bracket? Many people do.
The point is Roth Conversions provide an opportunity to use your early retirement years to optimize the tax efficiency of the assets in your portfolio by paying any taxes in lower income years.
If you expect that you could benefit from Roth Conversions one day, I highly recommend that you keep enough cash or cash equivalents available in the 2-5 years leading up to Roth Conversions so you can pay the tax bill on the conversions.
It would be a shame to cannibalize your new Roth dollars to pay taxes for the conversions.
10) Open a 529
If you have kids and plan to provide financial support for their education, a 529 education savings plan is a great way to do that.
It works similarly to a Roth IRA in that contributions are made on an after-tax basis and allowed to grow tax-free. Withdrawals are also tax-free if used for a qualified educational expense.
Additionally, in 33 states plus D.C., contributions to a 529 may be deductible on your state income tax returns. The limitations vary greatly, so check with your state to understand the tax implications fully.
The major downfall of 529 plans is the relative lack of flexibility for using the money.
Education is the only tax-free option for withdrawals, and you’ll even owe a penalty if your withdrawal isn’t due to a scholarship being provided to the beneficiary or a few other select exceptions.
Even if you can manage to remove funds without a penalty, you’ll owe income tax on the gains if you don’t spend it on education.
In 2024, Secure Act 2.0 ushered in an option for 529 funds that remain after a beneficiary has completed his or her education.
You can now use up to $35,000 of 529 assets to fund Roth IRA contributions for the account beneficiary up to their annual IRA contribution limit, assuming they have sufficient working income.
This flexibility does help, but you will be best served by not over-contributing to a 529.
11) Use Your Estate
Finally, there are several opportunities to save taxes in your estate planning. Actually, there are more than I can cover in this post and it’s already quite long, so I’ll just hit a couple of common things.
First, you can save your family quite a bit of headache and expense by establishing a trust as a mechanism for distributing assets in your estate instead of forcing them to probate a will.
Technically, a relatively small portion of the expense is related to taxes, but I thought I would include this thought anyway.
Another important strategy to keep in mind the fact that appreciated assets like stocks and real estate, receive a free step up in their tax basis when ownership is transferred as an inheritance.
Unfortunately, many people jump the gun and either transfer all or partial ownership of these assets prior to their death, forfeiting a significant tax benefit in the process.
You should especially avoid the temptation to serve as the co-owner of real estate or other accounts prior to the death of a parent or other loved one.
There are other ways to manage custody and help elderly loved ones without sacrificing the improved tax basis.
The final thing I’ll suggest is to be thoughtful about how your beneficiaries are designated on your tax-advantaged accounts like IRAs and HSAs.
We already pointed out that HSAs don’t make the best inheritance because they are fully taxable to beneficiaries in the year they are received.
You should also keep in mind that the difference in marginal tax rates between you and your heirs may call for strategic planning as well.
For beneficiaries in higher brackets, the net exposure to taxes will be reduced if you leave Roth assets to them.
On the other hand, if they are in lower brackets, the net benefit will be higher if they inherit tax-deferred accounts.
In either case, heirs of IRAs will have 10 years to liquidate the account, so there is quite a bit of runway for making distributions allowing room for further tax planning.
Wrap Up
I did not intend to make this a 4500-word post, but it just sort of swelled as I wrote. I suppose I shouldn’t be all that surprised given the complexity of our tax code.
My hope is that you have found at least a few of these tax saving opportunities helpful and that it results in real tax savings for you and your family.
Be sure to check out our YouTube channel for more about tax efficiency and other investing topics.
As always, thank you for your interest.
