When it comes to taxes, the good news is that we all have until May 17th to file and pay our federal income taxes. (Your state income tax deadline may be a different story.) Parents can also qualify for the higher child tax credit. The bad news is there isn’t much you can really do to reduce your 2020 taxes. However, there are steps you can take to reduce your taxes in 2021 and beyond (short of having more children):

1) Increase pre-tax contributions to your employer’s retirement plan and/or a traditional IRA.

If your employer offers a pre-tax retirement plan like a 401(k) or 403(b), you can contribute up to $19,500 for 2021 and an additional $6,500 if you turn age 50 or older this year. (If you also have a 457 plan, you can contribute that same amount to that plan too.) If you don’t have a retirement plan at work, you can contribute up to $6,000 to a traditional IRA (plus another $1k if you turn age 50 or older this year) and deduct the contributions from your taxable income. If your employer has a plan, you can still contribute to a traditional IRA, but how much you can deduct depends on your income. (Also note that the deadline to contribute to an IRA for 2020 has also been extended to May 17th.)

Whether you’re contributing to a pre-tax 401(k) or taking a deduction on an IRA, you’re not paying tax on that money now, but you still have to pay taxes on it when you eventually use the money. So how is that a benefit? The obvious one is that since most people need less income in retirement, you may end up retiring in a lower tax bracket.

But even if you don’t, there’s still a good chance that you’ll end up paying a lower average rate on that money. That’s because not all of your income gets taxed at your tax bracket. For example, let’s say you have a joint taxable income of $100k. That puts you in the 22% tax bracket. But the first $19,750 is only taxed at 10%, the next bucket of income up to $80,250 is only taxed at 12%, and so only the $19,750 above that $80,250 is taxed at the 22% rate. According to this calculator, your overall average rate would actually be 13.5% for 2021.

When you contribute pre-tax money to these accounts, it “comes off the top” so in this case, it would have all been taxed at that 22% tax rate. However, when you withdraw that money, some of it may not get taxed at all because of deductions and credits, and a lot of it may end up getting taxed at those lower brackets. So if you retire with the same taxable income, you’ll still probably end up paying a lower average tax rate on those 401(k) withdrawals. Of course, you could also end up paying a higher tax rate in retirement if your income is higher or if rates go up. This brings us to…


2) Contribute more to a Roth retirement account.

Your employer may offer you a Roth option in your retirement plan or you may be able to contribute to a Roth IRA. (If your income is too high to contribute directly to a Roth IRA, you can always try the “backdoor” method.) The contribution limits are the same as the traditional accounts, but the Roth accounts won’t reduce your taxes now. The advantage is that as long as you have the account for at least 5 years and are over age 59 1/2, all the earnings are tax-free so it doesn’t matter how high your future tax rate is. (Having tax-free income can also help you qualify for health insurance subsidies if you retire before qualifying for Medicare at age 65.)

3) Contribute more to an HSA (health savings account).

If you have a high-deductible health care plan, you may be eligible to contribute up to $3,600 for individual coverage or $7,200 for family coverage to an HSA. You can also save an additional $1,000 if you’re age 55 or older. These basically combine the best of both worlds because the contributions are pre-tax, and you can withdraw the money tax-free for qualified health care expenses. Once you turn age 65, you can also withdraw the money penalty-free for non-medical expenses, but it will be taxable.

4) Contribute more to FSAs (flexible spending accounts).

Like HSAs, FSAs allow you to contribute money pre-tax and then use the money tax-free for qualified health care or dependent care expenses depending on the type of FSA. But unlike HSAs, you may have to use the money by the end of the year or lose it so this should really be for those expenses you know you’ll have like prescription drugs, glasses and contact lenses, or day care. (Some companies may allow you to roll your unused FSA balance into 2022.) If you’re in the 22% tax bracket, you’re essentially getting a 22% discount on those expenses.

5) Contribute to tax-advantaged education accounts.

If you have a child that you’re planning to spend money on for education, you may want to consider putting some money away now for that. Some tax-advantaged options include a custodial account (first $1,100 of earnings are tax-free and the next $1,100 are taxed at the child’s rate), US Savings Bonds, a 529 plan, and a Coverdell Education Savings Account. The last three allow you to potentially use the earnings tax-free for qualified education expenses. Money can also be used from an IRA for qualified education expenses without penalty. You can compare the various options here.

6) Use tax shelters for the most tax-inefficient investments.

If you have money invested outside the above accounts, use your taxable accounts for the investments that get taxed the least. For example, municipal bond interest is generally federal tax-free, while other bonds generate interest that is fully taxable at ordinary income tax rates. Dividends and capital gains are taxed at lower rates as long as the investment is held for at least a year, but high turnover mutual funds could generate a lot of earnings that are taxable at ordinary income tax rates. Direct ownership of an investment property allows you to deduct interest, property taxes, and other expenses as well as depreciation, but REITs (real estate investment trusts) don’t offer those tax deductions while also generating a lot of taxable income.

7) Minimize taxes on stocks.

Individual stocks make particular sense in a taxable account. If they lose value, you can sell them and use the losses to offset other taxes as long as you don’t repurchase them within 60 days. If they appreciate, try to wait at least a year before selling them so you can qualify for the lower capital gains rate. You can also gift them to a charity or a child with a low or no tax bracket or even hold them for your lifetime and then pass them on tax-free to heirs.

One important thing to keep in mind is to not let the tax tail wag the dog. (If your only goal is to minimize taxes, the best move would be to put your money in losing investments.) Instead, always focus on your goals first and think of these as ways to minimize the effect of taxes as obstacles in achieving them. If you want help, consider consulting a qualified tax professional or financial planner. Your employer may even offer access to one for free through a workplace financial wellness program.