You would be amazed to know the massive difference in the taxes you can save if you plan better. Tax planning is the process of ensuring that all the factors that can reduce your taxes are utilized. If you plan your taxes well enough, you will be paying the lowest taxes possible. People who are smart enough to take advantage of the opportunities save enough money that would have gone into paying taxes. Such money can then be invested or used for other purposes, especially in contributing to retirement plans.
The goal is; to minimize taxes and maximize investment.
Several factors come into consideration when planning taxes this way. They include but are not limited to the timing of income and increased savings for a retirement plan.
We all understand how straightforward increases in retirement savings can reduce our taxable income. If you earn $70,000 and $7,000 goes into your retirement savings, your taxable income is $63,000. If your retirement savings are increased to $10,000, you can only be taxed on $60,000, which reduces your taxes.
This is not always easy to accomplish because of the pressure to complete the sales. For businesses, you may delay the completion of sales until after the accounting date so that the profit falls into the next tax period. By deferring income, too, you postpone taxes until you're in a lower tax bracket.
If you earn dividends from stocks and you're in a higher tax bracket, you can transfer lots of it to your trusted dependents in a lower tax bracket. That way, the taxes are smaller, and you can save more income.
Tax planning doesn't just mean deferring income. You could also accelerate revenue if you fall into a higher tax bracket. So tax planning can broadly involve four strategies. They are:
Accelerating income
Accelerating deductions
Deferring income
Deferring deductions
Accelerating income and deductions would work if you are in a lower tax bracket but expect to move to the higher bracket in the coming tax year. So, you can accelerate your income so that more is immediately taxed at a lower rate. The opposite is what happens when you defer income and deductions, especially if you expect to fall within a lower tax bracket soon.
However, everything about tax planning revolves around timing. Get the timing wrong, and you could lose more than you bargained for.
Deferring income
When you defer your income to sometime later, you can minimize the taxes you are liable to pay on your current income. This may be strategic for those who may fall into a lower tax bracket in the coming year or sometime later, as is with retirement plans. But if not, you can still minimize your taxes and smartly invest the gains.
Let's look at a 401(K) plan, for example. If you defer your income by contributing a part of your earnings, you can then reduce your taxable income while at the same time postponing the taxes till when you withdraw money from your plan. That way, you've been able to defer income to reduce taxes and increase your savings. Remember that by the time you are starting from your retirement savings, the taxes won't be as much as when you saved them.
If you are interested in increasing your retirement investment, deferring your income is a smart way to do it. It is best to withdraw from retirement savings when you retire for full benefits because you pay a 10% penalty tax for early withdrawals. Your taxable income would reduce, and you'll only be taxed when you withdraw the savings.
Another way of deferring income is to invest in permanent life insurance or savings bonds.
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Tiffany Gaskin