3 Simple Strategies to Save on Taxes

Hey, what's up, everyone, and welcome to the School of Personal Finance. With the end of the year quickly approaching, I wanted to talk about tax planning and how important it is to have a strategy in place. So in this video, I'm going to go over three simple strategies that everybody could implement in order to save on taxes. I'm also going to give a high-level overview about how the brackets work and your taxable income and tax deductions and all the things that you might need a refresher on in order to implement a great tax strategy. All right, let's get to it. Real quick, head over to schoolofpersonalfinance.com, sign up for my newsletter. I'm sending out awesome resources once a week. You could also sign up to work with me one-on-one. I call it First Step to Financial Freedom, where we create your financial plan over three Zoom calls. So go ahead and check that out. Let me start out by saying that I am not a CPA. I am not a tax expert. So before you implement any of these strategies, make sure to talk to your CPA or do your own research, all right? Because this might not be the best strategy for you, depending on your financial situation. All right, so the first strategy is called filling up your lower tax brackets. So now we have what's called a progressive tax system, and there are seven different tiers, seven different tax brackets. The first one is 10%. So your first $22,000 worth of taxable income is taxed at 10%, right? So you're paying $2,200 in federal income taxes on your first $22,000. And now these dollar amounts with the brackets, I'm referring to if you are married filing jointly, right? The numbers are different if you file single or if you file head of household. And these tax brackets, they're expanded for 2024 as well. And then all the way up to $89,450, you are paying 12%, and the brackets keep going up. So you could be in a 24% tax bracket, but that doesn't mean that you're paying 24% on all of your taxable income. It goes through these brackets, all right? So the strategy is to fill up the lower brackets. So for example, if you make $70,000 a year in taxable income, then you are leaving some of that 12% tax bracket empty. The strategy is to fill it up, to do things to cause taxable income, because we want to take advantage of these 12% rates. Historically, they are very low. And in 2025, the Tax Cuts and Jobs Act is going to be expiring. So we could expect that tax rates are going to be going up in the future. And 12% is a very low rate. So if you're in that situation where you have room left in that 12% tax bracket, it might be a very smart move to fill it up. So how do you fill up a tax bracket? There are a couple of different strategies that you could do. One that comes top of mind is doing Roth conversions. So that's when you take money that you have in pre-tax accounts, like a traditional IRA, and you convert it to a tax-free account, which is a Roth account. And by doing that, you are creating taxable income in the year you do the conversion. So in that example I just went over, let's say that you have $10,000 in a traditional IRA. You could convert it to a Roth IRA. You will owe taxes now on that $10,000 on the conversion. So you have to make sure that you have the money to be able to pay the taxes on it. But then that money will be in the Roth, and it will grow tax-free forever. So it could be a very smart idea to take advantage of low tax brackets if you have the opportunity. I can make the argument, depending on your personal situation, that the 22% tax bracket, it is also a good idea to fill that tax bracket up. If you make a good income and you expect to for a long time, then being able to fill up that tax bracket through Roth conversions, or maybe through pushing out other income that you have available to you, it could make a lot of sense. So another one that comes top of mind is if you have the option of contributing to a Roth 401k through your employer. So if you contribute to a traditional 401k, that reduces your income. So now you get a tax deduction in the year that you make those contributions to a traditional 401k. But if you have room left in a 12% tax bracket, or maybe even in a 22% or a 24% tax bracket, depending on your situation, then you could decide to contribute to a Roth 401k instead. So with a Roth 401k, you don't get the tax break now, you don't get the deduction, but then the money inside of that Roth 401k, it will grow tax-free forever, as long as you follow the rules. Now, if you're in a high tax bracket, if you make a good income, then you are not looking to push out income. You don't want to be paying taxes in the 32%, 35% tax bracket, that might not make sense for you. But if you 12%, if you have some of the 22%, that could make sense to choose Roth over traditional. Now, two terms that you hear thrown around that are a little confusing are your marginal tax rate and your effective tax rate. So your marginal tax rate, that is the rate that you are paying on your last dollar of income. So let's say that you make, you're marry filing jointly, and you guys make $100,000 per year of taxable income. That would put you in a 22% tax bracket. So for every additional dollar you make at this point, you'd be paying 22% on that. But your effective tax rate, that is the percentage of your income that you're paying in taxes. So a simple example would be, on that $100,000 of taxable income, you might only owe $7,000 of federal income tax, depending on your family size, if you have child tax deductions, depending on your situation. So in that example, if you owe $7,000 in federal income taxes based on $100,000 of taxable income, your effective tax rate would only be 7%. So you see, you're in the 22% tax bracket, that's your marginal tax rate. But your effective tax rate, the percentage of your income that you actually paid in taxes, is only 7%. All right, now the second simple strategy, it piggybacks on the first, and it is what we call tax diversification. So it is great if you could go into retirement having tax diversification. You've probably all heard of asset allocation. This is tax diversification. You want to have money in tax deferred accounts, like traditional 401ks, traditional IRAs. You want to have money in tax-free accounts, like Roth IRAs, Roth 401ks, HSA accounts. And then you want to have money in regular taxable accounts, which are like brokerage accounts. All right, so obviously traditional IRAs, 401ks, Roth IRA, 401ks, those are retirement accounts, where a regular brokerage account, that is money that you could get access to before you are retired. So it's a great strategy to start building out the three different buckets of tax diversification. It gives you so much control in retirement for your tax brackets, where you're going to be pulling money from. So now our parents' ages, right? 99% of them, they have their nest egg in traditional IRAs, traditional 401ks. So every time they pull money out of there, they are paying taxes on it. A lot of them, like my parents, they have pensions, social security, and then traditional retirement accounts. So all of that income is taxable. They have zero control over their tax brackets, and it pains them to take money out of their retirement accounts because they don't want to pay the taxes on it. A better way to approach this is to have these different buckets. So if you could go into retirement, let's say that you are lucky enough to be able to retire in your early 60s, right? Let's throw 62 out there. It might not make sense to take social security at an early age. Hopefully, you won't want to do that. Hopefully, you'll delay it as long as possible, so you could continue earning those credits. So if you have years there where you're not taking social security, and you have money in traditional accounts, Roth accounts, and savings, or taxable brokerage accounts, now you could completely control your tax bracket, and you could take advantage of those lower brackets. And there are some very high-level strategies that you could do. So for example, you could do Roth conversions. If you have no income, right, you could live off of your savings and do Roth conversions and fill up those 10 and 12% tax brackets by moving money from traditional IRAs to Roth IRAs so that it will be tax-free later on in your life. Another thing you could do is you could sell some stocks, some winners, forced capital gains that you have in your brokerage account. If you don't have any other income, then you could actually fill up a 0% capital gains tax bracket up to a certain point and not pay any taxes on your capital gains. And then even beyond that, you could then do Roth conversions to continue filling up the 12% tax bracket. So you have a lot of flexibility in retirement if you're able to build out these buckets now. So my advice for you is to start, to open up that brokerage account and start funneling money into it. You probably already have a traditional IRA or traditional 401k. Start building out that Roth piece as well. An ideal scenario is you go into retirement with maybe 30% of your money in traditional and then maybe 50% of your money in Roth, which would be amazing. And then maybe 20% of your money in savings and taxable brokerage accounts so that you can really control it. And then in an ideal world, you put social security off until the last possible time. Who knows what that will look like by the time we get there and hopefully everything is still going the way as planned with social security. But as of right now, social security, it really is the best annuity, the best pension that is out there for retired people. And hopefully it's the same by the time we get there. But as you can see, when I showed you the tax brackets before, is that if you're in the 32% or 35% tax bracket, then choosing a Roth 401k, it's not the best choice because you want the tax deduction now because you're in such a high tax bracket. So it really does depend on your situation. And doing a Roth IRA, it might not even be an option for you. Your income would be too high to be able to contribute to a Roth IRA. Maybe you could do a backdoor Roth IRA, which is a conversation for another day. But it is harder to fill that Roth bucket when you are in a higher tax bracket. You really want to take advantage of that in your early years when you were in lower tax brackets and focus on building out that Roth piece. All right. And then the third simple strategy is called tax-loss harvesting. And all this is, is that towards the end of the year, you look for losses that you might have in your brokerage account. So obviously you need to have a brokerage account. You need to own stocks or funds or bonds or whatever in order to take advantage of this. You can't do this in retirement accounts. So in your brokerage account, if you have some losers in there that you could sell, realize the loss. Each year, you could take $3,000 worth of losses and offset your regular income with it. Anything above that, well, first of all, it will offset any capital gains you have. So if you have any winners that you have sold throughout the year, then these losses will offset the gains on that. But if you have more losses than you do in gains, then you're able to take the first $3,000 of that to deduct off of your income. But anything beyond $3,000, then it will be carried over to future years. So now you have to look through your account and see what you have losses in. So like, for example, if you were as lucky as me to own PayPal or Disney, stocks that really have not done too well over the last few years, you could go ahead and sell those at a loss and be able to take that tax write-off on your tax return. So being able to do the $3,000 every year, it's just a good strategy if you have available. The losses are in there for you to take. But you do have to be careful. If you want to own those stocks, then it might not be a good idea to do that. You have to worry about what's called the wash sale rule, where you have to wait a certain period of time before you could buy those stocks back. So you just want to be aware of how that works. But it is a very simple, good strategy to tax loss harvest. And you hear that as a buzzword with like these robo-advisors, where they talk about that they will automatically do tax loss harvesting for you throughout the year to take advantage of your losers to offset gains on your winners or to just be able to take that tax deduction each year. All right, everyone, that is it for this one. I hope that you found it helpful. Please hit that like button if you enjoyed this video. Make sure to subscribe to the channel. Head over to www.SchoolOfPersonalFinance.com. Sign up for my newsletter. I would love to see you over there. Shoot me an email if you would like to talk shop a little bit. I love talking to all my subscribers. So at any point, if you want to shoot me an email, rich at www.SchoolOfPersonalFinance.com. Thanks. Bye.