Stay Ahead of the Curve: Adjust Your Budget for Tax Changes
Advice on re-evaluating personal budgets and saving plans based on anticipated changes in individual income tax rates or deductions
As 2024 unfolds, significant shifts in the tax landscape are on the horizon, and young professionals need to stay ahead of these changes. The Tax Cuts and Jobs Act (TCJA) of 2017 brought about substantial tax reductions, but many of these benefits are set to expire at the end of 2025. Now is the time to strategize your financial planning to mitigate potential tax increases and optimize your savings.
Impending Changes to Income Tax Rates
The TCJA lowered tax rates across the board, but without legislative intervention, rates will revert to higher pre-2017 levels. Here's what to expect:
Marginal Tax Rate Increases: For example, the 22% tax bracket could rise to 25%, and the 24% bracket might increase to 28%.
Impact on Take-Home Pay: If you earn $80,000 annually, an increase from 22% to 25% could mean paying approximately $2,400 more in federal taxes yearly.
Standard Deduction Reduction: The standard deduction, which nearly doubled under the TCJA, may decrease, leading to higher taxable income.
Budget Adjustments to Consider
To prepare for these changes, it's crucial to reassess your financial habits:
Analyze Your Expenses: Use budgeting apps or spreadsheets to track your spending meticulously. Identify non-essential expenses that can be reduced or eliminated.
Increase Your Emergency Fund: Aim to save at least 6 months' worth of living expenses. This buffer can protect you against unexpected financial hits due to higher taxes or economic downturns.
Adjust Withholding Allowances: Consult the IRS withholding calculator to adjust your W-4 form, ensuring the correct amount is withheld from your paycheck to avoid a hefty tax bill.
Maximizing Deductions and Credits
With potential changes to deductions, it's time to optimize your tax strategy:
Consider Itemizing Deductions: If the standard deduction decreases, itemizing may provide greater tax benefits. Keep detailed records of mortgage interest, charitable contributions, and medical expenses.
State and Local Taxes (SALT) Deduction: The current $10,000 cap on SALT deductions may be adjusted. If you live in a high-tax state like New York or California, this could significantly affect your tax liability.
For instance, if you pay $15,000 in state income and property taxes, lifting the cap could allow you to deduct the full amount, reducing your taxable income by an additional $5,000.
Retirement Contributions as a Tax Shield
Investing in retirement accounts is a powerful way to lower your taxable income:
Maximize 401(k) Contributions: For 2024, the contribution limit is projected to be $23,000. Contributing the maximum could reduce your taxable income substantially.
Example: Contributing $23,000 to your 401(k) on a $100,000 salary reduces your taxable income to $77,000.
Traditional vs. Roth IRA: Decide between a Traditional IRA, which offers tax deductions now, or a Roth IRA, which provides tax-free withdrawals in retirement.
Anticipating Economic Factors: Inflation and Tariffs
Economic policies can indirectly impact your finances:
Inflation Effects: With inflation rates hovering around 3%, your money's purchasing power decreases over time. Invest in assets like stocks or real estate that historically outpace inflation.
Potential Tariffs Impact: Proposed tariffs on imported goods could lead to price increases on everyday items. This means higher living costs, so budgeting for essentials like groceries and clothing may need adjustment.
Proactive Tax Planning Strategies
Implementing advanced tax strategies can minimize your tax burden:
Tax-Loss Harvesting: Offset capital gains by selling underperforming investments. If you have $5,000 in capital gains and $3,000 in losses, your taxable gain reduces to $2,000.
Health Savings Accounts (HSAs): Contribute up to $3,850 for individuals or $7,750 for families. Contributions are tax-deductible, and withdrawals for medical expenses are tax-free.
Education Credits: If you're paying for education, the Lifetime Learning Credit offers up to $2,000 in tax credits for qualified expenses.
Stay Informed and Seek Professional Advice
Tax laws can change rapidly. To stay ahead:
Monitor Legislative Updates: Follow credible news sources and the IRS website for the latest on tax legislation.
Consult a Tax Professional: A Certified Public Accountant (CPA) can provide personalized advice, helping you navigate complex tax scenarios and optimize your financial strategy.
Action Plan for 2024
Review Your 2023 Tax Return: Understand where your money went and identify areas for improvement.
Adjust Your Budget: Factor in potential tax increases and higher living costs due to inflation or tariffs.
Optimize Your Investments: Align your portfolio with your financial goals and risk tolerance, considering tax-efficient investments.
Plan for the Future: Set financial goals for the next 5, 10, and 20 years, incorporating potential changes in the tax landscape.
Conclusion
The approaching changes in tax laws present both challenges and opportunities. By taking proactive steps now, you can position yourself to minimize tax liabilities and maximize savings. Remember, the key is to stay informed, plan ahead, and make strategic financial decisions that align with your long-term goals.
That potential jump from 22% to 25% on the $80k bracket is a game-changer for younger investors. Maxing out that $23,000 401(k) contribution while TCJA rates are still in play could be the most profitable trade of 2024 for most readers.