3 ways to be more tax-efficient year-round

It’s easy to avoid thinking about your income taxes until just before the April deadline. In fact, according to the Internal Revenue Service, 20-25% of all Americans wait until the last two weeks before the deadline to prepare their tax returns. Common reasons filers procrastinate are because they are too busy, or they just plain forgot. An effective way to not delay the inevitable and help reduce the stress of filing taxes is to do what you can throughout the year to minimize what you’ll owe.

Including tax efficiency as part of your financial strategy might be easier than you think. And it's an important topic to understand. The 2022 Thrivent Retirement Readiness Survey¹ found that the most valuable piece of advice people would have given their younger selves would be to learn about tax implications for their retirement savings.

Consider these three ways to help stay tax efficient before you file in the spring.

Maximize retirement contributions

Two of the most popular retirement savings accounts are the 401(k) and individual retirement account (IRA). How do you choose between the two? Good news— you don't have to!

Factor in child tax credits & college savings plans

For many parents, one pathway to helping their children succeed is through education; however, the price of college has seen consistent ticks upward. Today, the average cost of a four-year degree is more than $35,000. And while recent debt relief efforts have helped some students and graduates chip away at their loan balances, it can be hard to know what resources the future may hold.

Consider HSAs or FSAs

An FSA is a tool some employers offer that allows employees to set aside pretax dollars to pay for certain out-of-pocket expenses. There are two types of FSAs: one for health care costs and one for dependent and child care expenses.

Investing for your future retirement goals can help benefit you at tax time every year. Contributions to the following qualified retirement accounts have distinct tax benefits.

Your contributions to a 401(k), 403(b)or a similar salary deferral employer-sponsored retirement plan are great ways to be tax-efficient while saving for your future. The traditional version of these accounts are "tax-later accounts", meaning your contributions reduce your taxable income during the year by that amount. Instead, your tax liability will occur once you withdraw funds. 

• 2022 contribution limit: $20,500
• 2023 contribution limit: $22,500
  

As an additional boost to retirement savings, catch-up contributions are available if you are 50 or older.

• 2022 catch-up limit: $6,500
• 2023 catch-up limit: $7,500
  

Your employer also may offer a Roth version of their retirement plan, like Roth 401(k). It works much like the traditional versions of the plans in that it's funded with contributions from your paycheck and offers a pre-selected list of investment options. The annual contribution limits are also the same.

Where Roth accounts differ from traditional plans, which are funded with pre-tax dollars, the contributions made to Roth accounts already have been taxed so no additional tax liability will be incurred down the road (given you've met withdrawal eligibility requirements)². A Roth account may be most appropriate if you believe you are not yet in your peak earning years and you may be in a higher tax bracket in retirement.

IRAs offer a way to invest outside of your employer's plan. While the contribution limits are lower than employer plans, both traditional and Roth IRAs offer tax benefits. You have until the federal tax filing deadline of April 15 to make contributions to traditional and Roth IRAs for the previous year.⁵

• 2022 contribution limit: $6,000
• 2022 catch-up limit: $1,000

• 2023 contribution limit: $6,500
• 2023 catch-up limit: $1,000

Let's explore the differences between a traditional and Roth IRA.

You typically are able to take a tax deduction for contributions to a traditional individual retirement account (IRA). However, if you or your spouse participate in an employer-sponsored retirement plan you must meet the income thresholds in order to tax advantage of the tax deduction.³

While there is no tax deduction for Roth IRA contributions, if you meet the Roth IRA income threshold,⁴ all future earnings grow tax-deferred and distributions you take after age 59½ will be tax-free as long as it’s been at least five years since your first contribution.²

Raising a family is both priceless and expensive. Here are two options that can help you financially.

The Child Tax Credit is meant to help families with qualifying children get a tax break.

It’s a tax credit, which means it reduces your taxes due on a dollar-for-dollar basis. However, there are income thresholds above which the credit begins to phase out. For the 2022 and 2023 tax years, the credit provides of maximum of $2,000 per qualifying dependent child under age 16. To qualify, income thresholds for single taxpayers and heads of household are $200,000 ($400,000 for joint filers).

If you’re planning to help your children with education expenses, a 529 education savings plan⁶ may be a tax-efficient option.

These college savings plans are sponsored by states and let you set up an investment account to either prepay tuition costs at eligible colleges and universities or make after-tax contributions that grow tax-deferred. Any earnings on the investments are not taxable if the funds are used for qualified educational expenses.

While you cannot deduct contributions to 529 plans on your federal income taxes, most states with an income tax allow residents to deduct a portion of their contributions or receive a tax credit.

If you have access to a flexible spending account (FSA) or health savings account (HSA), they are both tax-efficient ways to help you manage the rising cost of healthcare.

Both can reduce your taxable income for the year and be used to pay for qualifying medical, dental and other eligible healthcare costs. But be aware of their differences.

If your employer offers FSAs, your contributions are typically made through payroll deduction on a pre-tax basis, which reduces your taxable income. However, the account does not belong to you. If you leave your job or don’t use the funds during the year, you lose the money—unless your employer allows some carryover.

In 2023, you can contribute up to $3,050 to an FSA.

To qualify for an HSA, you need to have a high deductible health insurance plan. You can make contributions until April 15 for the previous tax year, and any funds you contribute up to the annual limit are yours if you leave your employer and carry over from year to year. Any earnings grow tax-free.

In 2023, you can contribute up to $3,850 for yourself, or $7,750 for your family, to an HSA.

Be mindful of the contribution limits and withdrawals for eligible expenses for FSAs and HSAs, or you could face tax penalties or forfeit unused funds.⁷

Finally, have you thought about life insurance? If you or your spouse dies, income taxes may be affected adversely. Sometimes called a “widow’s penalty,” it happens with the shift from married filing jointly to single filer. The surviving spouse’s tax rate may stay the same or even rise despite a drop in family income.

While you can’t predict the future, you can plan for it. The death benefit from life insurance is generally income tax-free and could help your family during a difficult transition.

A financial advisor can help you take the right precautionary steps to shelter your finances from the unexpected. While Thrivent advisors do not provide specific legal or tax advice, they can partner with you and your tax professional or attorney.

Want tax resources at your fingertips? Check out our tax resource center.