How to Reduce Your Taxes as an Educator or Government Worker
I often get asked how you can reduce your income taxes as an educator or government worker. I have five ways that you can reduce your federal tax liability that I can share. As an educator or government employee, you will find that they can be easily implemented. Some reduce your taxes now, and others reduce your future taxes.
1. Max out your 401(k) or 403(b) Plan. Contribute up to the max to your workplace retirement plan. Your maximum contribution will be $20,500 if you are under 50 in 2022. Maximizing contributions are often overlooked and not taken advantage of since many workers view that they should only contribute up to the match. Still, if you contribute up to the deferral limit, your income will reduce the taxes you pay.
2. Max out your HSA or FSA Plans. You could have a Health Savings Account or HSA or a Flexible Savings Account or FSA for Health Care and Dependent Care. Both are ways of reducing your income and saving on taxes. The HSA is especially powerful with its triple tax advantage of tax-free contributions, tax-free earnings, and tax-free distribution on qualified medical expenses. Also, take advantage of employee benefits such as life and disability insurance; you can reduce your taxable income by getting these pre-tax benefits.
3. Max out Roth IRA. This one is often overlooked. The benefit here is that you get tax-free distributions on the earnings and growth. You don’t save taxes since it is after-tax money in the current time but save over the long run. Keep in mind there are income limits for direct contributions to a Roth IRA. You can do a backdoor Roth IRA if you exceed the income limits. With Roth IRA contributions, you don't reduce taxes now but in the future. If you are in a higher tax bracket in the future, the Roth IRA is incredibly effective.
4. Deferred Compensation Plans or 457 plans. One retirement account unique to government and public educators is the 457 plan. These plans are not aggregated with the 403(b) or 401(k) plans, so you can defer an additional $20,500 under 50 in these plans in 2022. In addition, if you are quitting your job, there is an added benefit of not having a 10% penalty for taking money out of the plan under 59.5. Finally, other long-service catch-up provisions are available with your 457 plan.
5. Save in a Brokerage Account. A final way to reduce your income taxes is to contribute to a brokerage account and hold equities (preferably low-cost ETFs) for at least one year to get 15-20% long-term capital gains on the earnings. Long-term capital gains can be significantly lower than your marginal tax rate. Also, you can purchase municipal bonds for a brokerage account, which are tax-exempt from federal taxes. Finally, if you are in a state that has an income tax, you can also reduce your state income taxes on municipal bonds purchases from your state.
These are the most common ways to reduce your federal income taxes when working in education and government. The obvious is to max out your 401(k) or 403(b) plan. But many of us don’t do this, so we leave cash on the table. Another option is to take advantage of the employee benefits, especially in health care, reducing our tax liability.
But one of the best ways to reduce taxes is to give to charity. You could contribute to a Donor Advised Fund and use this contribution to reduce your federal income taxes. The great benefit is reducing your taxes and supporting a worthy cause. You would need to exceed your standard deduction to take advantage of the tax benefits of a Donor Advised Fund, but this can be well worth it. You can set up a donor-advised fund at most major brokerages. You take a tax advantage in the contribution year and can keep the money in the fund until you distribute it to the charity.
Contact me below to learn more about tax planning and strategies to reduce your income taxes. Income tax planning is vital, and you should also contact an accountant to look at the impact of what I propose above on your specific income tax situation.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid federal tax penalties. Individuals are encouraged to seek advice from their tax or legal counsel. In addition, individuals involved in the estate planning process should work with an estate planning team, including personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.