How to Minimize Your Tax Burden While Working

With tax time on the horizon, we will dive into a few topics focused on how to minimize your tax bill. This week we explore ways to lower your taxable income while you are still working.

But before we start, it’s important to know that your investments can be classified into 3 buckets:

1. Tax deferred – includes 401(k) and IRA’s, where you make a contribution before you pay taxes, lowering your taxable income (tax savings today), but you have to pay taxes when you make withdrawals

2. After tax – this includes Roth investments, where you contribute after-tax dollars (pay taxes today), you get tax free growth and do not have to pay taxes on withdrawals

3. Taxable – includes savings or traditional brokerage accounts where you are taxed on dividends and interest payments and capital gains depending on how long you hold your investments

Contribute to Retirement Accounts

Retirement accounts are probably the best way to save money, and in most cases, we love them. Not only do these contributions help you build a secure financial future, but they can also reduce your taxable income (either today or in the future). Take advantage of employer-sponsored plans and consider contributing the maximum amount allowed each year. 

Whether you are utilizing a traditional IRA or 401(k) or Roth IRA or Roth 401(k), there are many opportunities to help with your tax burden. Where you are contributing (Traditional vs Roth, employer plan vs IRA) will likely depend on your current tax situation. For example, if you are in a high-income bracket today, it may make more sense to max out your traditional 401(k) to reduce your taxable income and leverage a backdoor Roth IRA strategy for additional savings. However, with tax rates scheduled to increase at the end of 2025, Roth accounts may prove beneficial for a wider range of people.

Health Savings Accounts (HSAs)

Health Savings Accounts offer a unique triple tax advantage – contributions are tax-deductible (like an IRA), the growth is tax-free (like a Roth), and withdrawals for qualified medical expenses are tax-free. If you have a high-deductible health plan, an HSA can be a powerful tool for both your current and future healthcare needs. There are penalties if you do not use the money for qualified expenses or meet the age requirements, but we will address these stipulations another day. In addition to HSAs, you may also qualify for other employer related opportunities through flexible spending accounts (FSAs), commuter benefits and other employer provided benefits.

Tax Credits & Deductions

Investigate available tax credits that can directly reduce your tax liability. Examples include the Child Tax Credit, Education Tax Credits, and Energy efficient tax credits. Make sure you meet the eligibility criteria and take advantage of these credits to maximize your tax savings. And, of course, let your accountant help guide you through this.

Separately Managed Accounts

If you have built up a nice retirement fund nest egg and are sitting on excess savings, a separately managed taxable investment account may make sense for you. We typically only use separately managed accounts (individual stocks) to closely track the performance of the S&P 500 Index. Although we are not huge fans of tax-loss harvesting, using a separately managed account can help manage capital gains and losses. This can give you more control of your taxable income and offset gains with losses to minimize your overall tax liability when you need to draw from the account.

Consider Tax-Efficient Investments

We love (most) index funds. Besides usually having cost advantages compared to actively managed strategies, many index funds provide greater tax efficiency when used in taxable accounts. These investments are designed to minimize taxable events, allowing you to keep more of your investment return. In most cases, holding bonds in tax deferred (e.g., 401(k) or IRA) or after-tax buckets (e.g., Roth 401(k) or Roth IRA) can make more sense than holding them in a taxable account. But, if you need to hold them based on your risk profile, it may be better to utilize municipal bonds which can offer federal and state tax advantages.

Conclusion

Minimizing your tax burden while working requires a proactive and strategic approach. By leveraging retirement accounts, exploring tax credits, optimizing employee benefits, and making informed investment decisions, you can keep more of your income and build a solid financial foundation for the future.

At North River Wealth Advisors, we are committed to helping you navigate the complexities of taxation and financial planning. If you have questions or need personalized advice, don't hesitate to reach out. Your financial success is our priority.

Here's to a tax-smart and financially prosperous journey ahead!

Authored by Stephen Blahovec and Michael Rausch of North River Wealth Advisors.  We are an independent, fee-only financial planning and investment management firm located in Pittsburgh, PA servicing clients locally and across the country.  To learn more, contact us here.

This content is developed by North River Wealth Advisors from sources believed to be providing accurate information. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.