Tax Strategies for Career Professionals and Pre-Retirees

Looking for ways to reduce your taxable income is important whether you are beginning your career or have been working for twenty years.  Here are some options to consider as part an overall tax strategy.

Remember, an overall tax strategy looks at the big picture of your tax situation over time and should be discussed regularly as part of your financial plan, while tax planning should be reviewed at least annually to help you implement your strategy in the current taxable year.  The time to prepare and review your tax plan is not when it’s time to file, but earlier in the year when there is still time to adjust.

401(k) Contributions 

One key piece of investment advice advisers offer to young people is to max out contributions to any company-sponsored 401(k) or retirement plan to the extent you are able and can still meet expenses.  Compound interest is remarkable.  Setting aside retirement money at an early age and continuing to contribute to your retirement savings throughout your career can help to both reduce your annual tax bill and improve your financial security as you approach retirement.  If you can’t afford the maximum contribution to the plan, try to contribute enough to earn any company matching funds.  Contribution limits for 401(k)s, 403(b)s, most 457 plans, thrift savings plans (TSPs), and other qualified retirement plans in 2022 are $20,500 with an additional catch-up contribution of $6,500 for those over age 50.  The contribution limits are reviewed and adjusted by the Internal Revenue Service (IRS) annually so be sure to check with your employer to confirm the limits before making your election.

Most retirement plan contributions use pre-tax dollars and if you invest the money before you receive it, you won’t be tempted to spend it on something else.  Establishing a habit of saving early in your career will serve you well in the future.  Remember, retirement savings are portable so if you change jobs, tax-free rollover options are available to you. They might include rolling the funds over to your next employer’s plan or opening an Individual Retirement Account (IRA).

Roth 401(k) Contributions

Offered by some employers, the Roth 401(k) option became available in the beginning of 2006.  Roth 401(k) contributions are made with after-tax dollars, so unlike the 401(k) contributions, Roth 401(k) contributions reduce your current net income.  But you pay no taxes on withdrawals from the plans when you retire. Roth 401(k)s may be appealing if you anticipate having a higher income tax bracket when you retire than your current tax bracket.  Contributions will be taxed at the lower rate you pay now and growth in the account is tax-free, as are distributions during retirement as long as the withdrawal is qualified.  To be qualified, the account must have been held at least five years and the withdrawal must have occurred because of a disability, on or after the death of an account owner, or when an account holder reaches at least age 59 ½.  Required Minimum Distributions (RMDs) are required for people who are at least 72 years old (70½ before Jan. 1, 2020) unless the individual is still employed at the company that holds the 401(k) and is not a 5% (or more) owner of the business sponsoring the plan.

IRA Contributions

Once you have maxed out your contributions to a company sponsored retirement plan, or if you don’t have access to a company sponsored retirement plan, you could consider contributing to an IRA.  The annual contributions limit for IRAs for 2022 is $6,000, with an additional catch-up contribution of $1,000 for those over age 50.  Traditional IRA contributions may be tax deductible in the year when you make the contribution, depending on your income level.  In addition, in order to contribute to an IRA, you must meet the compensation threshold and not exceed the income limits.  You should consult your accountant or tax preparer to confirm your eligibility to contribute to an IRA and determine if the contribution will be tax deductible. 

The SECURE Act repealed the age restriction for Traditional IRA contribution eligibility. Effective for 2020 and later taxable years, individuals with earned income can make Traditional IRA contributions at any age, not just for years before reaching age 70½. 

Roth IRA Contributions

Another option to consider is contributing to a Roth IRA.  Like a Roth 401(k), there aren’t any current year tax benefits to contributing to a Roth IRA, but your contributions and earnings grow tax free and there are no taxes on withdrawals once you’ve reached age 59 ½ and once the account has been opened for five years.  As mentioned above, the annual contributions limit for IRAs for 2022 is $6,000 (with an additional catch-up contribution of $1,000 for those over age 50) whether you contribute to an IRA or a Roth IRA.  You can also make partial contributions to both an IRA and a Roth IRA as long as they don’t exceed $6,000 in total.  Unlike the traditional IRA, there are no contribution age restrictions and no RMDs for a Roth IRA.  There are income limitations to open a Roth IRA so please consult your accountant or the IRS website to confirm your eligibility.

Roth IRA Conversion 

If you believe you may be in a higher tax bracket in the future when you start accessing your IRA funds, you might consider a Roth IRA conversion.  Through a conversion, you may save money by paying taxes now rather than later.  A Roth IRA conversion simply transfers retirement assets from a traditional IRA, simplified employee pension (SEP), simple IRA, or a defined contribution plan such as a 401(k) into a Roth IRA.  You will be required to pay taxes on the money you convert, however, you will be eligible to make tax-free withdrawals from the account in the future.

Having a number of account types for your retirement may help with tax diversification and provide greater flexibility to your withdrawal strategy as you need to access funds in retirement. 

How to Get Started

If you’re looking for assistance with tax planning, contact your trusted financial advisor, and they should be able to give you advice and guide you through the process.

About Chase Investment Counsel

Chase Investment Counsel is a family and employee-owned boutique wealth management firm that offers personalized investment services. Our clients include career professionals, those nearing or in retirement, and families experiencing financial transitions such as generational wealth transfer, widowhood, divorce, or sale of a business. Chase’s active, disciplined investment management team is focused on selecting individual stocks and bonds targeted to each investor’s specific financial goals and risk tolerance. Established in 1957 in Charlottesville, VA, Chase Investment Counsel manages more than $300 million in assets.