​​5 Ways to Save Money on Your Taxes Most CPAs Won't Tell you About

Paying taxes can feel discouraging. Here are five legal ways you can keep more of your money, rather than paying it in taxes.

Written by Caish Echols AFC®, CFP® / August 11, 2022

Quick Bites

  • The more money you contribute to a pre-tax 401(k) or SEP-IRA, the less taxes you’ll owe.
  • Using an HSA has a triple tax advantage and can completely avoid FICA tax.
  • Putting money into a 529 plan may save you on state taxes depending on where you live.

Would you be upset if you paid full price to buy a new vehicle, only to find out after the fact that there was a discount you could have used that would have saved you thousands of dollars? I would be. Crazily, this is exactly what happens each year with our taxes. Contrary to popular belief, there are legal ways to pay less in taxes and put more money in your pocket without being on the IRS’s naughty list.

So let’s break down the different ways you can reduce your tax bill next year.

Inside this article

  1. Contribute to a pre-tax 401(k)
  2. Contribute to a SEP-IRA
  3. Use an HSA
  4. Keep your tax withholding update
  5. Consider contributing to a 529

Contribute to a pre-tax 401(k)

Most full-time positions come with some sort of retirement plan. One of the most common retirement plans is a 401(k). With a 401(k) you elect a percentage (or dollar amount) of your salary to be taken out of your paycheck each month and contributed to your 401(k). Some 401(k) plans let you choose whether you want the money to go into a pre-tax 401(k) or a Roth 401(k). If you aren’t given the option, most likely you only have access to a pre-tax 401(k). When you defer money from your paycheck into a pre-tax 401(k) you reduce your next year’s tax bill.

Here’s how it works: Let’s say your annual salary is $60,000, making your gross monthly income $5,000. If you decide to defer 5% of your salary to your 401(k), $250 will be taken out of your paycheck each month adding up to $3,000/year. When you go to file your taxes, instead of owing taxes on all $60,000 of your salary, you only have to pay taxes on $57,000. You still get to keep that $3,000 in your 401(k), but you don’t have to pay taxes on it now. Instead, you’ll pay taxes on it when you take it out of your 401(k) during your retirement.

Depending on whether or not you expect a higher income now versus in retirement depends on whether or not you choose to do the pre-tax or the Roth option in your 401(k). However, each pre-tax dollar you put into your 401(k) will reduce the taxes you owe on your 2022 return (you can contribute a max of $20,500 in 2022).[1]

What Is a 401(k)?

What Is a 401(k)?

A 401(k) is the most popular employer-sponsored retirement plan. Find out how to use this tool to reach your retirement goals.

Find out more

If you’ve recently gotten a raise, now may be the perfect time to login to your 401(k) and increase your contributions to help offset additional taxes you’ll owe now that you’re earning more money. Increasing your 401(k) contributions is a great way to use your money for you, instead of just paying it to Uncle Sam.

Contribute to a SEP-IRA if you have side hustle money

SEP-IRA stands for a Simplified Employee Pension-Individual Retirement Account. You can contribute to a SEP-IRA if you are self-employed, have side hustle income or do freelance/contract work receiving a 1099. One of the great things about a SEP-IRA is that it reduces the income tax you owe at the end of the year and it can also offset some of the self-employment taxes you owe.

A SEP-IRA acts very similarly to a 401(k) plan. Each dollar you put in gives you a tax break now. Then you pay the taxes on the money when you take it out in retirement. Even if you have a W2 job that has access to a 401(k), you can also contribute to a SEP-IRA if you have net income in that business.

The maximum amount you can put in your SEP-IRA each year depends on the net income your business makes. You can ask your CPA or accountant to help you calculate this amount, or you can use an online calculator like this one from TD Ameritrade. It normally makes the most sense to contribute to your SEP-IRA closer to when you file your taxes. However, to help with cash flow, you could start setting aside 20% of your self-employment income each month so that you have the contribution ready when it’s time to make your SEP contribution.

Use an HSA if it’s offered to you

An HSA, or Health Savings Account, can have a triple tax advantage (if you use it correctly) plus it can help you avoid ever paying payroll tax. In order to open an HSA, you have to have a high deductible health plan or other HSA eligible plan.

FSA vs. HSA Accounts

FSA vs. HSA Accounts

Both of these tax-advantaged savings accounts help you save on health care costs, but they differ in crucial ways.

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But, let’s break down these tax benefits if you have an HSA, or get offered one in the future:

  • The contributions to an HSA go in tax-free. If you contribute to your HSA directly from payroll, it will work the same as it would with a 401(k). At the end of the year, any amount that went to your HSA, won’t be included in your taxable income.

  • The other cool thing to note here is that if you contribute directly to your HSA from payroll, you’ll never have to pay payroll tax on any of that money. If you contribute to your HSA on your own, technically that money has already been taxed. So when you file your taxes, you’ll receive a tax deduction equal to your contribution, keeping that amount out of your taxable income.

  • The money can grow tax-free. If you invest the money in your HSA and it grows, you don’t have to pay taxes on that growth. Win!

  • When you take the money out, if you use it for qualified health expenses, none of it is taxable. Even if you change jobs or change health plans and are no longer eligible to contribute to an HSA, you’ll still get to keep your account & all the tax benefits.

  • You can use the money in your HSA to pay for you, your spouse, or any of your dependent’s qualified medical costs without tax consequences.

  • Also, if you’re able to cash flow medical costs, you can leave the money growing in your HSA. Just save your receipts, and then in the future (even if it’s 10 years later), you can submit those receipts to your HSA provider and get reimbursed for those expenses all tax free!

Keep your tax withholding updated

Your tax withholding is what tells your employer how much in taxes they should take out of your paycheck each month. Although it sounds like a negative thing, it can make a huge difference. We’re talking about receiving a refund vs. having a $20,000+ surprise tax bill.

If you want to avoid surprise tax bills, it’s a good idea to review your withholdings every year. You can check whether or not you’re withholding enough by using the IRS’ withholding calculator. Each time you have a new life event, like getting married or divorced, adding another child to your family, moving states, receiving company stock, or getting a raise, it’s a good idea to update your withholdings. Those life events can affect how much you need to pay in taxes. Additionally, tax laws are always changing, so even if your situation hasn’t changed, the calculator can help you. Staying on top of this can keep you from a tax surprise in the spring.

Consider contributing to a 529 plan

A 529 plan is a special tax advantaged account that helps people save for college. You can open a 529 account for yourself, your child, or really anyone you know and, in the future, you can switch the beneficiary to whomever, whenever you’d like. Basically, you contribute money to the account that is then invested and grows as you save for college.

What to Know About 529 College Savings Plans

What to Know About 529 College Savings Plans

College is expensive. 529 plans can help you save more for your child’s education.

Find out more

More than half of the states in the U.S. have a tax deduction for people who contribute to a 529 plan. Although utilizing this tax hack won’t reduce the federal taxes you pay each year, it can reduce your state taxes depending on where you live. Generally, these contributions have to be made before the end of the year to get the tax benefit. How much they reduce your taxes and how much you can contribute to your 529 plan each year are state specific, so make sure you check your state’s rules before you contribute.

Even though there isn’t a federal deduction, there is a federal tax benefit; if the money you put into a 529 plan is later used for qualified higher education costs, all of the growth is tax free when the money is taken out.

Article Sources
  1. IRS.gov. “IRS announces changes to retirement plans for 2022”, https://www.irs.gov/newsroom/irs-announces-changes-to-retirement-plans-for-2022

About the Author

Caish Echols

Caish Echols AFC®, CFP®

Caish has worked in the financial planning industry for over 5 years, including working for one of the pioneer financial planners who brought fee-only financial advice to Millennials. She loves making the complexities of finance simple to understand and helping people follow their own paths.

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