Let Open Enrollment Help You Minimize Taxes

September 13, 2013

With tax rates where they are today, and potentially going higher in the future due to the ever-increasing national debt and Congressional spending habits, I get asked a lot of questions about how to minimize taxes. That’s always an interesting conversation because taxation comes in many forms (taxes on income, capital gains, and interest, not to mention all of the consumption taxes we pay) and across many timelines. Are we looking at ways to minimize this year’s tax bite or our lifetime tax bite? Sometimes there are tradeoffs. 

If we knew a few “simple” things, we could design the absolute perfect tax planning structure for everyone.  What are those “simple” things?  We could start with your date of death. What will tax rates be between now and then?  What will the stock market, bond market and interest rates do from a rate of return standpoint each year until your death? See, it’s really simple! In the absence of those pieces of information, we can look at today’s tax code and allow your thoughts about some of the questions above to inform your decisions about some tax strategies that you could employ during open enrollment.

Some things that I’ve seen people do to minimize their tax burden:

  • Maximize contributions to your pretax 401(k). This can reduce current year income by $17,500 (or $23,000 if you’re over 50).  This is a good strategy if you think that your income today puts you in a higher tax bracket than you’ll be in during retirement. This is a great way to reduce taxes today, in the current year.
  • Maximize contributions to a Roth 401(k) [same limits as the pretax].  This is a good strategy if you believe tax rates in the future are going to be higher than they are today and also if you are relatively young because one of the biggest “bang for the buck” features of the Roth is that all of the growth in the account (along with your original contributions) can be withdrawn completely free of taxation during retirement. Those who are under 40 years old have 20 years or more of growth and the tax savings from that can be HUGE if you’re looking at minimizing taxes over your lifetime, not just this year.
  • If your employer doesn’t offer a Roth 401(k), don’t sweat it.  You can contribute to a Roth IRA. You can contribute up to $5,500 ($6,500 if you are 50+).  It has the same benefits as the Roth 401k, but a lower contribution limit.
  • Maximize your Health Savings Account contribution.  These dollars can grow tax free and be an excellent source of funding healthcare expenses during retirement. Contribute pretax dollars, allow them to grow, pay for current year expenses out of your current cash flow/budget to allow growth to occur in the HSA. One of the major reasons people postpone retirement is uncertainty about how to fund health insurance premiums or medical expenses prior to Medicare kicking in. This can solve that problem while reducing your income (and therefore your tax burden) today.
  • Flexible Spending Accounts are amazing!  You can contribute pretax dollars for expenses that you KNOW you’ll incur in the areas of healthcare or dependent care.  Then, when you pay for the expenses, you’ll get reimbursed. It’s like paying for daycare or doctor visits with pretax dollars.  This is another area where you can reduce current year income and taxation for expenses that you’d pay for regardless of your contribution to this account. FSA’s are “use it or lose it” so make sure you will have expenses or else you forfeit the money and that’s worse that ANY tax you’d ever pay.

Your company may offer other benefits that help you manage your tax burden downward while providing a meaningful benefit.  Each year, open enrollment usually means you get one chance, one opportunity, to seize every tax benefit you can.  Will you capture it?  Or let it slip?  (Leave a comment if you know where the last few sentences originated…)