You’ve got an extra month to file your income taxes on time this year, but financial advisors suggest you don’t waste any time in planning how to turn tax advantages into retirement savings before next year’s deadline.
The Internal Revenue Service has extended the federal income tax filing deadline from April 15 to May 17, 2021. The move was made to help people still dealing with the pandemic and to give the IRS time to process the latest round of stimulus payments.
“Even with the new deadline, we urge taxpayers to consider filing as soon as possible, especially those who are owed refunds,” IRS Commissioner Chuck Rettig said in a statement.
Filing earlier, and with direct deposit, is the quickest way to get your tax refund if you have one coming. It also speeds processing any stimulus money you’re owed or may be entitled to in the future.
Still Need an Extension?
If May 17 is still too soon for you, you can request an extension until October 15. Just file Form 4868
with the IRS through your tax professional or tax software. You’ll still have to pay the taxes you owe by May 17, but you won’t have to file the paperwork until October 15.
Look Beyond One Year’s Taxes
Financial and retirement experts also suggest now is the time to begin planning a tax strategy for the 2021 tax year that will pay off for your retirement savings when you file your income taxes this time next year.
That may begin with talking to a financial or tax advisor if you haven’t already.
“Just remember a tax preparer is not a tax advisor,” Alan Becker, president and CEO of Retirement Solutions Group, told RetireGuide.
Becker points out that a preparer is typically focused on completing your income taxes for the year. A tax advisor can be part of a team of financial advisors who work together to minimize your long-term tax bill while maximizing your retirement investments and savings at the same time.
“It all comes down to finding a planner, not just a preparer, if you actually want a tax-efficient future,” he said. “Because tax-free money in retirement is better than taxable income in retirement.”
Becker suggests a “holistic” approach to planning your retirement. Finding a retirement planner who will look at how your 401(k), IRA, Medicare plans, legacy planning and charitable giving will all work together.
This can not only save you on taxes in the long run, but will make sure your retirement income doesn’t result in surprise expenses — such as higher Medicare Part B or Medicare Part D premiums.
“You want to make sure the team at the firm you’re working with on your financial and retirement planning are all working together,” Becker said. “Because we want our clients — our people — working with the three wise men, not the three blind mice.”
Start Planning for Next Year’s Tax Deadline Today
Even if you haven’t done your taxes for 2020, it’s not too early to start planning for 2021.
“It’s a little late in the game to put into play most steps that can help you reduce your 2020 tax bill,” Jim Braun, president of Tri-State Retirement said in an email. “But now is definitely a good time to start thinking about ways you can improve your tax situation for next year.”
Braun recommends that before filing your taxes for the 2021 tax year, you look closely at your ability to put your money in investments, savings and even charitable gifts that will give you a tax advantage.
Tax Efficient Savings and Investments to Consider
- Traditional IRA: You don’t pay income taxes you put into a traditional individual retirement account (IRA) until you take the money out. So you will save on your tax bill now.
- Roth IRA: You still have to pay income taxes at the end of the year on the money you put into a Roth IRA. But any money you take out after retirement is tax-free income.
- 529 Plans: People typically think of these plans as a way to save for your kids’ college education. But you can also use them to pay for your children’s K-12 education if you send them to a private school. As long as you spend money on qualified education expenses, you won’t have to pay federal taxes on the account or its earnings.
- Health Savings Accounts: HSAs give you what Braun calls “a triple whammy” of letting you deduct your contributions for the year, defer taxes on any earnings in the account and let you take withdrawals tax-free. But you have to use the withdrawals for qualified medical expenses.
A qualified financial professional can help guide you through the right combination of these and other options to minimize your taxes while maximizing your retirement benefits. The ideal plan should be personalized to your needs.
Charitable Tax Breaks: Give Now, Save Later
Both Becker and Braun recommend charitable giving as a powerful way to reign in your tax bill while benefiting your community. Charitable giving to a qualified organization can reduce not only your income tax bill, but your capital gains and estate tax burdens.
Each recommends a donor-advised fund if it makes sense for your charitable giving. The minimum amount to open one of these charitable giving funds can range from $5,000 to $25,000 or more at some financial institutions that administer them, according to Consumer Reports.
Donor-advised funds are personal charitable accounts. You can open them in your name or in the name of multiple donors, but they are held by a nonprofit organization.
“Let’s say you sell a stock and, instead of paying the capital gains tax, you place the proceeds in a donor-advised fund,” Braun wrote. “You can claim the full amount as a charitable deduction.”
You don’t even have to donate all the money at once. The money you would have spent on capital gains taxes stays in the fund and you can dole it out in smaller chunks for years while it gains interest.
A donor-advised fund can also take advantage of today’s relatively low tax rates to shield you should you face higher tax rates in retirement.
“Just heap your current donations together — two, three, five years of it into a donor-advised fund,” Becker said.
That way, you take advantage of low tax rates while getting the charitable deduction now.
Becker has a favorite quote from Judge Learned Hand, “Nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions.”
Professional tax and financial planners can help you find tax efficiencies you may have never expected existed, but work for your particular situation.