tax planning

Why It’s Smart to Start Tax Planning in July

July is officially here, which means you’re probably enjoying the nicer weather and the fact that you don’t need to worry about filing your taxes for another 9 months.

However, July is actually the perfect time to assess whether you can improve your tax efficiency when you’re filing your taxes next year. You can begin optimizing your tax planning as early as January, as all your financial activities since the new year are reflected in your next return.

Ultimately, every person’s tax situation is different, and our trusted advisors are happy to help you navigate your own opportunities to improve your approach. We’d love to connect and talk to you in person.

In this article, we’ll discuss two common mid-year tax strategies that our clients often ask about. One may help reduce your long-term tax obligations in certain scenarios (a Roth IRA conversion), and the other may reduce your short-term taxable income for the upcoming year (increasing your 401k contributions).

It should be noted that both of these methods have their drawbacks and advantages. Converting a traditional IRA into a Roth IRA only makes sense in certain tax situations, and maximizing contributions to your 401k plan simply defers annual tax payments until a later date.

When to Consider a Roth IRA Conversion

If you anticipate being in a higher tax bracket during your retirement years, converting a traditional IRA into a Roth IRA is one way to potentially reduce your tax payments over the long term.

Unlike a traditional IRA, the money you contribute to a Roth IRA is taxed at the moment of contribution. In a traditional IRA, money is taxed at the moment of withdrawal. When you convert a traditional IRA into a Roth IRA, you’ll be paying taxes at your current tax rate instead of a potentially higher tax rate in the future.

While this means you will pay taxes on your Roth IRA conversion up-front, the benefit is that withdrawals from a Roth IRA are tax-free — just as long as you are over the age of 59 ½ and the funds have been in your Roth IRA account for five or more years.

In addition to tax-free withdrawals under those parameters, there are other benefits to a Roth IRA in your retirement years. For example, Roth IRA funds are not subject to the same Required Minimum Distributions (RMDs) as traditional IRAs, which means you have more freedom with Roth IRA funds after you retire.

Why the Time is Right to Consider a Roth IRA Conversion

The Tax Cuts and Jobs Act (TCJA) of 2017, which went into effect in 2018, reduced federal income taxes by 3% for Americans in the most common tax bracket. In 2026, the TCJA is set to expire, which means federal income tax will increase to pre-2018 rates for most Americans.

Think of it as a “sale on taxes” between now and 2026.

As such, the time may be right for you to consider a Roth IRA conversion in 2024 or 2025. In most cases, you will be paying taxes at a lower rate than you would on a Roth IRA conversion or traditional IRA distribution in 2026 or beyond.

Why to Consider Increasing Your 401k Contributions

While a Roth IRA conversion only makes sense in certain scenarios, may be a good idea to invest a higher percentage of your paycheck in your employer-provided 401k retirement savings plan or IRA if you do not have an employer sponsored plan.

The earlier you are able to increase your contribution, the better. For one thing, a higher 401k contribution from paycheck to paycheck will decrease your taxable income for the year.

Furthermore, the sooner you are able to increase the percentage of your 401k contribution, the more time those retirement funds will be able to grow via compounding interest.

Many employers also offer the benefit of 401k matching programs, which will help your retirement savings grow even more. For example, if you contribute 5% of your salary to your 401k plan, your employer may match that contribution with an additional 5%.

Keep in mind that your 401k contributions are tax-deferred. This means the funds in your 401k plan are taxed upon withdrawal, and only count toward your taxable income in the year withdrawal. You are simply deferring those tax payments until you receive your 401k distribution upon retirement.

Let’s Talk About Your Tax Planning Strategy

At Financial Services of America, we know that tax planning can be complex and confusing. Whether you’re looking to help reduce your tax payments this year or further down the line, we take pride in guiding every one of our customers through their very own opportunities to save.

From tax planning to legacy planning, we offer extensive services that will help you assess your needs and optimize your strategies. We’d be happy to review your latest tax filing and identify your ideal path forward. Simply schedule a conversation with our trusted financial advisors, and let’s start working toward your goals.