Although the legislative landscape changed rapidly during the COVID-19 pandemic, when it comes to tax planning, many individuals are now looking at how potential changes may impact their 2022 tax return.
While we don’t yet know what actions Congress will take this year, there are tax planning strategies that individuals can leverage now to help prepare. We recommend talking them over with your CPA and financial advisor to help ensure you leverage the best strategies for your unique situation.
Why is Tax Planning Important?
The reason why tax planning is important is simple: it saves money and helps you avoid overpaying your taxes. Aside from that, however, tax planning will help you better understand what you’re spending money on and how you can get rewarded for planning for retirement or advancing your education.
1. Convert traditional IRAs into Roth IRAs
If you’re anticipating that tax rates will go up, converting traditional IRAs into Roth IRAs will allow you to take advantage of lower current tax rates. Unlike a traditional IRA, a Roth IRA does not have required minimum distributions when you reach age 72, and the distributions are not taxed when you take a withdrawal in retirement. When planning for your Roth conversion, be mindful of where you lie within your tax bracket. If you’re on the lower end, you have room to make a Roth conversion without getting bumped into the next tax bracket.
2. Use your estate tax exemption
Many people are concerned that the lifetime estate and gift tax exemption of $11.7 million ($23.4 million for a married couple) will decrease to $5 million, $3.5 million or potentially as low as $1 million. If you have a sizable estate, gifting assets to your children or into a trust this year can allow you to use the exemption while it’s still at $11.7 million. Gifts made under current law would be grandfathered in, even if the exemption does decrease.
3. Set up a SEP-IRA for your business
Small business owners should also consider setting up a retirement account for their business. A SEP-IRA allows employers to contribute to traditional IRAs set up for employees — including the business owner — up to the lesser of 25% of the employee’s compensation or $58,000 for 2021. This amount is much higher than the $6,000 limit ($7,000 if age 50 or older) individuals are allowed to contribute annually to a traditional or Roth IRA, making them a very attractive tool for retirement savings.
Finally, if you receive a regular paycheck, you can look into increasing your withholding. This helps you avoid owing large sums when tax season comes around and if you go over, you’ll end up getting a larger refund when the time comes. Since most people and small businesses pay too much in taxes every year, tax planning is essential.