Category Archives: Tax/Tax Savings

Spring Cleaning!

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Everyone thinks of January 1st as the time to start fresh and change things we want to change, but I see spring as an even more opportune time for this.

Here are eight SPRING CLEANING items you can tackle now:

  • Tax planning: Did you owe more than you expected on your taxes? Was it a one-time thing or does this tend to happen every year? Review your current paycheck and adjust your withholdings as needed (using form W4), or talk with your tax preparer about paying estimated tax payments throughout the year.
  • Tax planning: Did you get a very large refund? You need to adjust how much is being withheld. Don’t give the IRS an interest free loan. That extra money could be put to much better use for your benefit
  • Tax planning: Could you have saved more on taxes in 2023 if you had increased your retirement contributions or added money to a deductible IRA? Make adjustments to your paycheck contributions now so you are not in the same position next year.
  • Employer Benefits: If every year feels like “crunch time” during open enrollment, now is great time to review the benefits offered to you and ask your HR team for deeper explanations or clarifications if you do not understand something.
  • Emergency Fund Checkup: Make sure your emergency fund is fully funded or consider boosting it if needed. Aim to have enough saved to cover 3-6 months’ worth of living expenses.
  • Investment Portfolio Review: Evaluate your investment portfolio to ensure it aligns with your risk tolerance and both short and long-term goals. Consider rebalancing if necessary. Do you have the right types of investments in the best type of account? It can make a big difference over the long term.
  • Educate Yourself: Use this time to learn more about personal finance topics that interest you. Whether it’s investing, retirement planning, or debt management, increasing your financial literacy can pay off in the long run. Working with a trusted advisor will speed up this learning tenfold.
  • Make a list: what is in your head that keeps you up at night regarding your finances? One of my clients refers to this as her “financial brain dump”, which she then sends to me for safekeeping. 😉 Just writing it all out can help take a load off your shoulders and give you more clarity, making tackling each one over the next several months seem less daunting.

Let’s face it, when the sun is shining, the days are longer and the temps are rising, we are typically more motivated in just about anything we do!

This Triple Scores You a Homerun

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Despite the snow on the ground and freezing temperatures outside, we are at least beginning to see the daylight lasting a little longer, the first sign that we “are on the other side” of winter.

Another sure sign of spring approaching for us hearty New Englanders is when the Red Sox report to Florida for spring training, and that time has arrived!

With baseball in mind, this month I introduce an underutilized and often misunderstood savings vehicle being offered by more and more employers.

Read on to learn how using a health savings account (HSA) can offers a TRIPLE TAX SAVINGS, ultimately scoring you a HOMERUN.

The Basics of an HSA

An HSA is a savings account for health care expenses tied to what’s known as a High Deductible Health Plan, offered as a health care option through your employer.

This type of account is different from a Flexible Spending Account (FSA), where you can lose any unused portion of your dollars set aside for a given year.

The money set aside in an HSA stays with you forever.

Even if you leave your current employer, your HSA dollars go with you. And as an added bonus, you are also allowed to invest your contributions. You don’t have to use them in that year.

How the high deductible health plan works and whether it is right for your circumstances is a newsletter for another time, but many who currently have this type of plan with an HSA don’t understand the benefits of the HSA in and of itself.

Triple Tax Advantaged

Your contributions are pre-tax, so they lower your taxable income in the year they are made. Think of this tax savings in the same way you think of your pre-tax 401(k) contributions.

You can invest your contributions and they will grow tax free forever, meaning any growth of your contributions is also NOT taxed. This account is like a Roth IRA in this regard, so for high income earners who are phased out of making direct Roth contributions, this is an excellent tax savings vehicle that offers the same tax free growth one gets from a Roth.

Withdrawals, AS LONG AS USED FOR QUALIFED MEDICAL EXPENSES, are 100% tax free.

Boom!!! A Triple Tax Homerun!

With ever increasing health care costs in this country, this is a great tool for your future self to have a bucket of tax free money to help cover your future medical care costs, and a great tool in the current year to reduce your taxable income.

Wait! Don’t Throw That Out!

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Do you ever get so much “stuff” piled up on your kitchen counter…or desk, or side table or wherever you keep the “papers I may need but don’t have time to address right now” pile…that you just want to take it all and throw it in the trash?

Poof! Gone. Out of your mind, off your list. Except for the little voice in your head saying, “I hope I don’t need that for anything.”

You may not even know if you need to keep it because YOU DON’T EVEN KNOW WHAT IT IS!

Please allow me to introduce you to tax Form 5498.

Yes, I know, I touched on tax stuff last month – BORING – but hey, some things are just good to know. 

I’ll keep it short and sweet and introduce just this one tid bit today.

Form 5498 is mailed to clients in late May (that’s NOW) from their brokerage firm when the client has either contributed to or rolled over retirement assets into their IRA.

Why not until May? The tax deadline was last month!

That’s your answer.

Because we can make contributions for the prior year up until the tax filing deadline in April, they don’t send them out until AFTER the filing deadline.

“But didn’t I need it to file my return”, you ask? After all, it very officially looks like an official tax document!

NOPE! (is that officially a word?)

You do not. It is for informational purposes only. HOWEVER,…

You should review it (sorry), make sure it is accurate (mistakes do happen) and then retain it for your tax records.

Preferably not on the kitchen counter.

Are You REALLY Paying More in Taxes?

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Many folks feel overwhelmed by any talk around taxes. This is understandable. Our federal tax code can be a tough code to crack. It is a moving target of rules, income phaseouts and brackets which seem to change on a near constant basis.

And then there is simply the tax terminology in general that can be very confusing.

Effective Tax Rate vs Marginal Tax Rate

We follow a progressive tax system in the US. This means the amount of tax we pay on the first dollar we earn is less than the tax we pay on the last dollar we earn.

This progression results in a taxpayer’s Effective Tax Rate, or average overall tax rate, being less than their Marginal Tax Rate, or the tax rate of their final dollar(s) earned.

It tends to be a taxpayer’s marginal tax rate that is referred to most often, however it is the effective tax rate that more accurately reflects the average amount of tax you pay.

When a taxpayer falls into the 24% tax bracket for example, this is their marginal tax rate…24%. This simply means that the highest level of tax paid was 24%, even if it was only $1 of income in that bracket.

But their effective tax rate, the amount of tax they paid as a percentage of their overall income, is typically lower.

If your accountant supplies a comparison worksheet, you may be able to see your marginal and effective tax rates at the bottom of the worksheet.

Amount You Owe vs Total Tax Liability

If you look at page 2, line 37 of your 1040 for 2022, you’ll see “Amount You Owe”.

This is NOT your total tax liability for the year, which is up above on line 24, aptly named “total tax”.  

Amount you Owe is what is still left to pay of your total tax liability for the year, unless of course, you are getting a refund (which is on line 34 this year).

Your total tax liability in any given year depends on many different factors, so even if the figure on line 37 is higher this year, it doesn’t necessarily mean you are paying more in taxes.

You have to take into account what percentage of your overall income that number represents, which as you read above, is your effective income tax rate.

Let’s compare apples to apples:

In 2021, I picked 100 apples and had to give 20% of them to Uncle Sam.

That’s 20 apples (Total Tax, line 24).

I paid in 1 apple each month for the year (12 apples), so in April I still owed 8 more apples (Amount You Owe, line 37).

In 2022, I picked 200 apples and had to give 20% of them to Uncle Sam.

That’s 40 apples (Total Tax, line 24).

I paid in 1 apple each month for the year (12 apples), so in April I still owed 28 more apples (Amount You Owe, line 37).

Since owing 28 in 2022 is a lot more than owing only 8 in 2021, it would appear I paid more in taxes in 2022, and as a flat number of apples I did.

As a percentage of my overall apple income, I owed the same amount – 20%. 

I picked more apples (earned more income) but paid in the same number of apples each month (paycheck withholdings), so I had to play catch up in April and give a whole bunch of apples at once (amount you owe).

And despite the fact that I just explained to you how we have a progressive tax in this country, for the purposes of this illustration, I wanted to keep it simple and not overturn the apple cart.

I know, even trying to keep taxes simple can sound confusing, but I hope this helps shed at least some light on this intimidating subject!

Happy Thoughts

Always have eyes that see the best, a heart that forgives the worst, a mind that forgets the bad, and a soul that never loses hope.

– Unknown

Mega Back Door Roth: This Supersized Option is Good for your Health

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This topic has come up for me twice in the last week, so as is often the case, I’ve made it the topic for my newsletter this month.

I often get asked about the best strategies for saving outside of one’s 401(k).

My first caveat is that one size does not fit all, so what is a great solution for your neighbor may not be the best strategy for your situation.

I’ve highlighted in past newsletters the benefits of saving into an HSA, if you have one.

There’s also the option to contribute to an IRA, but regardless of which type of IRA you are to contributing to (deductible, non-deductible, ROTH, backdoor Roth), you are limited to how much you can contribute each year ($6,000 for 2020, $7,000 if you are over 50).

But what if you are in the fortunate position to be able to save more than this?

Introducing the Mega Backdoor Roth

There’s a little known strategy that I’m seeing as an option with more employers as of late. It’s the option to make after-tax contributions to your 401(k).

This strategy can offer tax diversification in retirement, but there are certain criteria that make it most effective.

It’s known in my industry as a  “Mega Backdoor Roth”, but you will not see it described that way in your benefits guide. It allows you to sock away more into retirement than the annual limits on a 401(k) or IRA.

Here’s how it works:

  1. Your 401(k) plan (your employer) allows after-tax contributions. If they don’t, game over.
     
  2. Your employer offers in-service distributions of these after-tax contributions to a Roth IRA while you are still employed or allows you to move the after-tax potion of your 401(k) to the Roth 401(k) part of the employer plan (if they offer one).

    If not allowed, game might be over, but not necessarily. It depends.

    I know, you hate when I say that. 
     
  3. You convert the after-tax contributions to one of the above as soon as allowed in order that the growth on your contributions is tax-free. You will now have a Roth IRA in retirement where there are no RMD requirements and distributions are tax free. Game changer.

When MIGHT this strategy be an effective strategy for you?

  • You already max out on your 401(k) contributions.
  • You max out on your HSA, if your employer offers one.
  • You make too much money for traditional IRA contributions to be deductible.
  • You max out a Roth IRA or backdoor Roth ($6,000 for 2020, $7,000 if you are over 50).

As with most financial planning and tax strategies, there are a lot of ins and outs and I try to stick to top level highlights to educate and make you aware of possible options available to you.  Consulting with your financial advisor or CPA is always prudent to determine which strategies are your best fit.

Financial Fitness Tip

Speaking of 401(k)’s, we are quickly approaching the end of 2020 (thank goodness). It’s a good time to check where you are with your 401(k) contributions for the year. You may have dialed back the % you contribute when things got a little coo coo in the markets or you had a temporary need for increased cash flow.

If things are looking brighter in your financial world, increase your % for these last few paychecks of the year and into 2021. And if there was never a hardship yet you are not maxing out, consider increasing it a percent or two now.

Little steps carry us a long way over time.

Things I Love

I will be pulling out my mom’s tattered and stained copy of her mom’s recipe to try to match what my grandmother used to create – a true masterpiece! I can never quite match it (my mother always said the same thing when she made it), but I can try.

And besides, it’s simply the tradition of making it and remembering them both that is my true Favorite Thing!

Happy Thanksgiving!

Sea of Letters

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You are likely in the middle of open enrollment, or will be soon, so I thought this month would be a great time to review some of the crazy acronyms you see as your eyes glaze over the 100+ page benefits guide from your employer.

I can’t say here which benefits are the “best fit” for you. Reviewing benefit options is part of what I do with my clients each year. Lives change. Families change. Benefit packages change. For many, the confusion stays the same. 

The Biggest Offenders

FSA – Flexible Spending Account
HSA – Health Savings Account
HRA –  Health Reimbursement Account

These are NOT the same thing.

I’ll get the HRA out of the way, as it is not as common as the other two. This is an EMPLOYER owned and funded account an employee can use for medical expenses. It generally stays with your employer if you leave, unless they offer a retirement continuation. 

FSAs are offered with a standard HMO or PPO (I’m going to assume you know these two old friends).

I wrote a newsletter on HSAs a few months ago and the triple tax benefit they offer. They are only offered in conjunction with a HDHP. 

HDHP – High Deductible Health Plan

Similarities

  • Both are employee funded, although some employers will make contributions as an added benefit.
  • Both are funded with pre-tax dollars. Always a PLUS.
  • Both are used to pay for qualified medical expenses. 

Differences

  • Pre-tax contribution limits are higher for the HSA than the FSA. The HSA also offers a catch up contribution for those over age 55.
  • The up front, out of pocket medical payments are higher for Team HSA/HDHP.
  • FSA contributions are forfeited if not used in the same calendar year. There is some flexibility for carry over and grace periods, but forfeiture is the general rule. 
  • HSA contributions are yours forever. AND they can be invested. AND they can grow tax deferred. 
  • Your FSA is not portable. If you leave your company, the funds in the account do not go with you. An HSA is yours forever. 

While the HSA offers more flexibility than the FLEXIBLE Spending Account (oh the irony), it does not mean it is the right choice for you, even if both are offered by your employer. Every situation is unique.

Almost done, but a distinction I explain in this next section is REALLY important.

STD  – Short Term Disability
LTD – Long Term Disability

Granted, you probably know these two acronyms, but are you aware of the distinction when it comes to whether this benefit it taxable or not? 

It all comes down to how the premium is paid. I’ve worked with many clients who were not aware of the key difference because most benefit guides don’t do a great job of explaining it. 

It makes a big difference in how much money you actually take home, should you become disabled. 

  • If premiums are paid by you with after-tax dollars, then the disability benefit will not be taxable.
  • If premiums are paid by your employer, then the disability benefit will be taxable. 

Most LTD benefits offer coverage for “60% of salary”. If that 60% is not taxed, you are in OK shape.

If that 60% is taxed, your monthly benefit will be significantly less than your regular pay. 

One final scenario offering a TAX FREE disability benefit: 

  • Your employer pays the premium BUT adds the amount paid on your behalf to your gross earnings. By you paying taxes on the premium, any disability benefit you receive will be tax free. 

If your employer offers a tax free disability benefit option, this is the option you want. Otherwise, you may want to consider a private policy to supplement your employer plan.

Financial Fitness Tip

I often tie in both personal and professional experience to my newsletter and this time is no different. I was in a minor fender bender this morning (thankfully, everyone is OK), so I thought this was a good time to touch on auto insurance. Ironically, I also worked on a client plan this week where I recommended they increase their coverage. 

Most states require a minimum level of insurance, and if you are using a lender, they require proof of this coverage as well. Many folks go with the minimum requirements for Uninsured/Underinsured coverage and Property Damage. I don’t recommend this. Increase your coverage limits where you can. Back in my 20’s, I worked for an auto insurer as a claims adjuster, and believe me, these coverages come into play more often than we would like. 

Things I Love

I could probably do an entire newsletter devoted to binge worthy shows. My current fave is “Heartland” on Netflix. It’s a modern day Little House on the Prairie, which of course was the favorite of my 7 to 11 year old self. As I said in my January newsletter about The Marvelous Mrs. Maisel, it allows me to fall asleep with a happy heart. 

From a Google review:
“This sprawling family saga takes place where an unfortunate tragedy has glued a family together to pull them through life’s thick and thin moments. Follow young Amy Fleming as she slowly discovers she possesses her now-deceased mother’s ability to aid injured horses as well as maintaining good relationships with those who are trying to get by one day at a time.” 

Netflix has all 13 seasons and Heartland has been renewed for its 14th. When I saw that, I knew it must be a hit! 

This Triple Scores You a Homerun

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The Basics of an HSA

An HSA is a savings account for health care expenses tied to what’s known as a High Deductible Health Plan, often offered as a health care option through your employer. This type of account is different from a Flexible Spending Account (FSA), where you can lose any unused portion of your dollars set aside for a given year.

The money set aside in an HSA stays with you forever, similar to how your 401(k) would work. So even if you leave your current employer, your HSA dollars go with you. And like your 401(k), you can invest them.

You own the assets in your HSA forever.

How the high deductible health plan works and whether it is right for your circumstances is a newsletter for another time, but many who currently have this type of plan with an HSA don’t understand the benefits of the HSA in and of itself.

Triple Tax Advantaged

  1. Your contributions are pre-tax, so they lower your taxable income in the year they are made. Think of this tax savings in the same way you think of your pre-tax 401(k) contributions. 
     
  2. You can invest your contributions and they will grow tax free, meaning any growth on the account is also NOT taxable. This works like a Roth IRA in this regard, so for high income earners who are phased out of making Roth contributions, this is an excellent tax savings vehicle that offers the same tax free growth one gets from a Roth. 
     
  3. Withdrawals, AS LONG AS USED FOR QUALIFIED MEDICAL EXPENSES, are 100% tax free.

Boom!!! A Triple Tax Homerun!

Now the caveat is that although you can make contributions to this account on an annual basis to pay for current medical expenses, the goal is to instead pay out of pocket and invest that savings, like you would any other qualified savings account, allowing it to grow tax free for as many years as possible.

With our ever increasing health care costs, this is a great tool for our future selves to have a bucket of tax free money to help cover our future medical care costs.

Are You REALLY Paying More in Taxes, or Does it Just Feel That Way?

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A friend reminded me this past week of the story I tell on my website about my dad and taxes. “Don’t just file those away”, he said to me years ago. “Look them over and get an understanding of what’s going on”.

It was an early catalyst for discovering my love of personal finance.
  Many folks feel overwhelmed by any talk around taxes. This is understandable. Our federal tax code can be a tough code to crack. It is a moving target of rules, income phaseouts and brackets which seem to change on a near constant basis.

Effective Tax Rate vs Marginal Tax Rate

We follow a progressive tax system in the US. This means the amount of tax we pay on the first dollar we earn is less than the tax we pay on the last dollar we earn. This progression results in a taxpayer’s Effective Tax Rate, or average overall tax rate, being less than their Marginal Tax Rate, or the tax rate of their final dollar(s) earned.

It tends to be a taxpayer’s marginal tax rate that is referred to most often, however it is the effective tax rate that more accurately reflects the average amount of tax you pay. When a taxpayer falls into the 24% tax bracket for example, this is their marginal tax rate…24%. This simply means that the highest level of tax paid was 24%, even if it was only $1 of income in that bracket. But their effective tax rate, the amount of tax they paid as a percentage of their overall income, is typically lower.

Total Tax Liability vs Amount You Owe

If you look at page 2, line 23 of your 1040 you’ll see “Amount You Owe”.

This is NOT your total tax liability for the year, which is up above on line 16, aptly named “total tax”.  

Amount you Owe is what is still left to pay of your total tax liability for the year, unless of course, you are getting a refund.

Your total tax liability in any given year depends on many different factors. And even if the figure on line 16 is higher this year, it doesn’t necessarily mean you are paying more in taxes.

You have to take into account what percentage of your overall income that number represents, which as you read above, is your effective income tax rate.

Let’s compare apples to apples:

In 2018, I picked 100 apples and had to give 20% of them to Uncle Sam.
That’s 20 apples (Total Tax, line 16).
I paid in 1 apple each month for the year, so in April I owed 8 more apples (Amount You Owe, line 23).

In 2019, I picked 200 apples and had to give 20% of them to Uncle Sam.
That’s 40 apples (Total Tax, line 16).
I paid in 1apple each month for the year, so in April I owed 28 more apples (Amount You Owe, line 23).

Since 40 is more than 20, it would appear I owed more to Uncle Sam in 2019, and as a flat amount of apples I did, but as a percentage of my overall apple income, my taxes did not go up.

I owed the same amount as a percentage of my apple income…20%.

And since the amount I owed in April (line 23) was 28 instead of 8 this year, it may appear as if I owed more in 2019, but it’s because I didn’t pay enough apples each month along the way in 2019 (paycheck withholdings). Overall, I still paid 20% both years.

Now for purposes of simplicity in this example, I used a flat tax of 20% instead of a progressive tax that I explained up above. You may be thinking this would not happen, because if I picked more apples, I would have owed more than 20% this year. However, this example helps to demonstrate what the expanded tax brackets did for many Americans with the passing of the Tax Cuts and Jobs Act of 2017.

From 2018 through 2025, when this law is scheduled to sunset, many Americans can earn more while remaining in the same tax bracket, or in some cases a lower bracket, than they were in prior to 2018.

That sounds like a pretty good tax deal to me!