The Deadline to Reduce Your Tax Bill is Approaching
March 24, 2014Time is running out to stay off of Uncle Sam’s naughty list and complete those income tax returns prior to the April 15th deadline. (Even if you choose to file an extension until October 15, 2014 taxes are still due by April 15 to avoid paying interest and penalties.) Beyond making sure you aren’t missing out on any itemized deductions or tax credits, there are still some moves you can make to reduce your tax bill or increase your refund. Last minute contributions to deductible IRAs and HSAs are two effective strategies to lower your 2013 tax bill (or increase your refund).
One of the most common strategies is to make a deductible contribution to an IRA. The contribution limit is 100% of compensation up to $5,500 ($6,500 if you are 50 or older). However, if you are already participating in a retirement plan through your employer, the ability to deduct these contributions is limited based on your income. For the 2013 tax year, the ability to make deductible IRA contributions is not an option if you are a single filer with modified adjusted gross income (MAGI) of $69,000 or more ($115,000 for married couples filing jointly). If you’re married filing jointly with a spouse covered by a plan but you’re not, you can also make deductible IRA contributions if the MAGI is below $188,000.
Making deductible IRA contributions is less advantageous if you are in a lower tax bracket, have your peak earning years ahead of you, or see income tax rates increasing significantly in the future. In those cases it may make more sense to contribute to a Roth IRA to take advantage of tax-free earnings growth. Roth IRAs have different income limitations but the contribution amount is the same as deductible IRAs. If you are trying to decide which type of IRA (traditional vs. Roth) to invest in check out this helpful guide.
Did you know that you can still contribute to your HSA if you didn’t already max out your contributions for the 2013 tax year?
Most people like the simplicity of payroll deduction when it comes to setting aside funds into HSAs. What is often forgotten is that you have the ability to make direct contributions to an HSA outside of your employer by directly writing a check or setting up automatic transfers from your bank account. These lump sum or ongoing monthly contributions can potentially serve as a significant tax planning opportunity for HSA participants unaware of the additional time allowed to make contributions for the 2013 tax year outside of regular payroll deductions.
Let’s review why HSAs are so appealing in the first place. Not only do they provide much needed protection to help pay for future health-related expenses but HSAs can also benefit you by lowering your income taxes. You can contribute up to $3,250 for individual coverage and up to $6,450 for family coverage for 2013. If you are age 55 or older, there is an additional $1,000 catch-up contribution until Medicare eligibility at 65. Just don’t forget to include contributions made by your employer during 2013 along with your contributions for the 2013 tax year when determining how much you can possibly add to your HSA.
Example: If you are in a high deductible health insurance plan with family coverage and your employer contributed $800 to your HSA during 2013 and you had an additional $2,000 taken out through payroll deductions, you are still eligible to contribute an additional $3,650 to your HSA before the April 15th deadline [$6,450 annual family limit minus ($800 + $2,000)].
I realize that not everyone out there has the funds available to max out their health savings accounts. Let’s assume the same married couple in the example above is filing jointly and in the 25% marginal tax bracket (combined income between $72,501 and $146,400). If they chose to contribute an additional $2,000 to their HSA, they would still reduce their tax bill by $500. Contributing the maximum amount to an HSA will save up to $1,612.50 for family coverage assuming no employer contributions ($812.50 for individual coverage) at the 25% federal marginal tax bracket.
HSA contributions are considered an “above the line” deduction, which can help lower your adjusted gross income and potentially help qualify you for other deductions and credits that are income dependent. A key benefit of this tax deduction is that you do not have to itemize deductions to claim HSA deductions. HSAs are also portable, meaning you can always take it with you if you change employers or transition to retirement.
Health savings accounts are unique in that they offer triple tax exemption. The money that you put into HSAs lowers your taxable income today, grows tax-deferred, and comes out of your account tax-free as long as you use it for health-related expenses. With rising health care costs, this is a financial planning opportunity to consider.
What if you are healthy or don’t need access to your HSA funds? Unlike flexible spending accounts (FSAs), there is no “use it or lose it” provision. Therefore, you can continue to leave HSA funds in your account and let your balance grow from year to year. Health savings accounts can also provide a variety of investment options to maximize long-term growth potential.
Unlike deductible IRA contributions, health savings accounts do not have income limitations. The main qualifier is that you have to be covered by a high-deductible health insurance plan with a health savings account attached to it during the 2013 tax year. It is also important to note that like those last minute contributions to an IRA for the 2013 tax year, HSA contributions must be made by April 15 even if you are filing an extension.
If you are like millions of other Americans (this writer included) who have not fully completed a tax return, it’s not too late to take some final tax planning steps. Don’t forget about IRAs and HSAs when trying to legally avoid additional taxes from the IRS. Check out the resources below as well.
Resources: HSA Center
Why I Max Out My Health Savings Account (And You Should Too) (Greg Ward’s blog post)