Are you looking for some new ways to save money? The workplace offers an important starting point for tax breaks that can help you to do so – by not paying any unnecessary taxes. That’s because the U.S. government has deemed certain expenditures – like retirement savings and health care expenses – so important that they get preferential tax treatment.
The catch: in some cases, you have to plan for these in advance by pre-allocating your salary. That means: if you anticipate paying $2,500 a year in health care expenses, you can have that amount deducted from your paycheck (pre-tax) and you get reimbursed for expenses as the year goes on. But if you don’t spend as you’ve budgeted, you may lose the money you’ve set aside altogether.
In the following post, we discuss the five major ways you can reduce your tax bill by taking advantage of workplace tax breaks.
1. Boost Your 401k Contributions
Are you taking full advantage of your retirement savings at work?
401ks, or whatever workplace retirement you have are the first place to start. As we’ve written in Unlock Your Retirement Savings Potential: The 401k, 401ks are king not only because of their tax advantages – they’re made with pre-tax dollars and grow tax free – but also because they’re often accompanied by an employer match. (NB: A “match” means your employer may incentive you to save by supplementing your savings up to a certain percentage).
From day one, the 401k’s attributes mean you can almost double your money. If you save the maximum ($17,500) and you’re in the top tax bracket (39.6%) and your employer offers a typical match (50%), then you’ve already nearly doubled the amount of money you’ve effectively saved ($33,180). When that money sits in your retirement account and grows tax free, that means it grows faster. Fifteen years later, you may stockpile over 3x in your 401k versus a regular account. You’ll have to pay taxes on that money eventually – but only on withdrawals, so it’s still a great deal.
So where to begin with your 401k? If you’re lucky enough to have a 401k plan at work (as we outlined in Does the MyRA Solve the Retirement Saving Crisis?, 48% of American workers don’t actually have access to a plan), you typically sign up during enrollment period and select how much to deduct from your salary and what to invest in.
And as you’re saving, keep these guidelines in mind. For 2014, you’re able to able to contribute up t0 $17,500 in pre-tax dollars – if you’re 50, you can pre-allocate even more, to the tune of $23,000. And while you can withdraw money from your 401k at any time, in doing so you’ll not only have to pay your taxes
Still need some motivation to contribute towards your retirement? Besides free money and tax advantages, workplace retirement savings are great because they’re automatic: the funds are deducted from your pay before you’re tempted to spend them. After enrollment period, you can elect to increase your contributions throughout the year. It’s also a great idea to commit to a plan to increase your 401k savings by increments over time. So instead of spending your year-end bonus on a new TV set, why not put it towards your retirement – when maybe later that cash can buy you a TV set and a new stereo system?
2. Save in your IRA
401ks aren’t the only way to save towards your retirement at work. Some workplace retirement accounts are IRAs. For instance, small businesses with 100 or fewer people can offer a SIMPLE (Savings Incentive Match Plan for Employees) IRA. SIMPLE IRAs are an easy and inexpensive way for small businesses and start-ups to establish a retirement plan and contribute towards traditional IRAs for workers.
SIMPLE IRAs share some of the 401k’s great features. For instance, they have a match component. In fact, if your employers offers a SIMPLE IRA, it is required to contribute matching contributions up to 3% of compensation, or 2% nonelective contributions (i.e., if you contribute money to your SIMPLE IRA, your employer is required to match your contributions up to 3% of your salary; if you don’t contribute anything, your employer is still required to contribute 2% of your salary).
In addition, since you own your personal SIMPLE IRA – if you decide to leave your employer, the funds go with you. Similar to other retirement accounts, SIMPLE IRAs have contribution limitations: workers can only contribute up to $12, 000 in 2014; if you’re age 50 or older you can make a further annual contribution of $2,500.
Another type of IRA that employers can establish are SEP (Simplified Employee Pension) IRAs. SEP-IRAs are very flexible and can be established by employers for any size from business businesses to large size employers. SEP-IRAs are typically less costly to set up than traditional retirement accounts. What makes SEP-IRAs special is that only your employer contributes. This may or may not be a good thing – in tough times your employer may decide not to contribute to SEP-IRA. If you decide to leave your employer, you are fully vested and have full ownership over your funds. Annual contributions are limited to the lesser of 25% of employee compensation or $52,000 in 2014.
3. Pay For Your Health Benefits
Retirement isn’t the only way you can reduce your tax bill by pre-allocating your salary. You can also avoid paying taxes on the a predetermined portion of your salary that you spend on medical expenses.
Let’s start with the basics. In an employer-sponsor health plan, your employer typically covers the majority of the premium costs. Employers typically cover 85% of premiums for employees and 75% for dependents. The employee is then responsible for paying the remaining coverage. A word to the wise: if your benefits are offered through a “section 125 cafeteria plan,” you can pay your premiums in pre-tax dollars – this helps you save on tax today and pay for your medical benefits. Typically, there is an open enrollment in the previous calendar year to sign up for your health benefits.
Health insurance premiums aren’t the only way you can save on taxes. Flexible Spending Accounts (FSAs) and health savings accounts (HSAs) let you pay for medical expenses you know you’ll have with before-tax dollars.
As mentioned, FSAs let you set aside before-tax dollars to cover “qualified expenses.” As discussed in our post End the Year Right with These Simple Tax Tips, the two most popular types of FSAs are healthcare and transit. During your employer’s open enrollment (typically in November, or before year-end) you can choose how much money will be deducted from your paycheck in the coming year. To be reimbursed, you most likely need to submit a receipt to your employer or upload it to the flex spending account. Looking for a more convenient way to pay medical expenses? Some larger companies offer debit cards.
Similar to retirement accounts, FSAs have limitations – you’re able to contribute up to $2,500 annually. And the catch: as we outlined, you’ll forfeit your account balance if not used by the end of the year. You also forfeit your balance if you leave the company. Although some employers allow you to carry over $500 to the following year, you basically need to be accurate about estimating your upcoming medical expenses. (NB: if you have the $500 carryover, contributing at least that much to an FSA is a no-brainer).
The savings can really add up when paying for medical expenses in pre-tax dollar. For example, if you spent $1,000 on medical expenses, but didn’t contribute to your FSA, if you were in the top tax-bracket you’d have to make $1,369 before tax to cover these expenses. However, if you use your FSA, you can allocate $1,000 before tax – thereby receiving an instant tax break. FSAs are sponsored by employer, so ask your HR department about opening one today.
If you’re covered by an HSA-qualified High Deductible Health Plan (HDHP) and you’re not enrolled in Medicare, Health Savings Accounts (HSAs) offer a great way to pay for future qualified medical expenses and save on taxes. You can think of HSAs are like retirement accounts where you not only set aside savings but invest the money. The only difference is that you can access those funds whenever you want – but only for health-care expenses. From a tax savings perspective, that means they’re even more attractive than 401ks!
Relative to FSAs, HSAs are beneficial for three main reasons: 1) earnings inside HSAs are tax-exempt from federal tax and grow tax-free, and 2) there isn’t any “use-it-or-lose-it” rule to contend with – any remaining balance can be carried over to the following year, and 3) unlike FSAs, you own your HSA, not your employer. When you change jobs or relocate to another state, your HSA and its balance can go with you.
Are you contributing to your HSA? The biggest mistake employees make with their HSA is not funding it enough. Since your money is carried forward and accumulates, if you’re in a high deductible health plan it most likely makes sense to open an account. If you’re looking to take full advantage, you can contribute a maximum in 2014 of $3,300 for single coverage and $6,550 for family coverage. Are you age 55 or older? You can make an additional $1,000 “catch up” contribution. Your contributions can be invested and withdraw when you need them for medical expenses. Speak with your employer to find out when open enrollment takes place to open an account (NB: if you participate in both, make sure you find out how that limits your benefits).
4. Save on Your Commute to the Office
You can also pre-allocate your earnings before tax to help pay for your daily commute to work. It’s important to understand the rules – not everyone who commutes to work can take advantage of this tax break, only qualified transportation benefits are eligible.
If you drive to work, you can set aside up to $130 per month towards your commute. You can only claim this benefit if you travel in a “commuter highway vehicle.” The following must be met for your vehicle to quality as a commuter highway vehicle: at least at least 80 % of mileage must be used for traveling to and from work, and the vehicle must seat at least six adults (excluding the driver), with at least half the passengers travelling to work.
Do you ride the subway or bus to get to work? If you purchase a transit pass, you’re also eligible to allocate up to $130 per month towards your commute. Any pass, token, farecard or voucher that entitles you to travel mass transit at a discount or free of charge qualifies. Mass transit includes bus, subway, rail, or ferry. (NB: you can only claim a combined $130 per month for traveling by commuter highway vehicles and mass transit).
If you pay to park your vehicle at your place of work, you can allocate up to $250 per month for “qualified parking.” Qualified parking includes parking provided by your employer on or near your place of work. A word of caution – you can only claim this tax credit if you travel using commute highway vehicles, carpools or public transit.
If you believe you’re eligible for any of these benefits, speak with HR about signing up. Typically employers have a deadline each month for electing the amount to be withheld from your pay.
5. Contribute to FSAs for Dependent Care
Dependent Care Flexible Spending Accounts (FSA) assists parents with childcare expenses for children age 12 and younger (unless disabled), and other dependents, such as parents or grandparents, that live in your home for at least eight hours a day. You can use pre-tax money to pay for your eligible care expense. To qualify you must be working or attending school full-time. Only certain expenses are eligible – you can claim expenses for care at your home, a sitter’s, and daycare, although you cannot claim full-day kindergarten programs.
Married couples who file joint tax returns benefit most from this tax break. Married couples who file joint tax returns can contribute up to $5,000 per year, while couples who file separate tax returns can claim $2,500. If both your spouse and you work, it’s important to plan your FSA claims in advance to ensure your combined contributions don’t exceed the $5,000 yearly limit, otherwise the excess will be taxed.
Once again, it’s important to be aware of the rules. You can only claim Dependent Care FSA expenses incurred during the calendar year from January 1st to December 31st. Also, you can only submit expenses while you’re a participant in the plan. For example, if you resigned from your employer on September 30, 2014, claims made after October 1, 2014 are not eligible.
There are two important differences between Medical FSAs and Dependent Care FSAs: 1) Dependent Care FSAs don’t automatically allow you to carry over $500 to the following calendar year and 2) Dependent Care FSAs aren’t pre-funded. It’s important to plan your child care expenses in advance to know how much to allocate to your FSA. Similar to traditional FSAs there is a “use-it-or-lose-it” rule, where any remaining account balance at the end of the year is forfeited to your employer. However, some employers offer grace periods of up to two and a half months after the end of the year to use any remaining balance from the previous year.
Enrolling in a Dependent Care FSA is similar to the process with other FSAs in that it occurs during open enrollment. Open enrollment and grace periods can be different between employers, so speak with your HR team to get the nitty-gritty details.
Benefits: Saves Taxes and Lower Your Tax-bracket
The main benefits of pre-allocating your salary are 1) paying less income tax and 2) enjoying tax-free growth if those funds are invested. In addition, if you save enough, you may end up lowering your tax-bracket. We’ve already gone over the former examples, so now we show you how you can lower your tax-bracket.
Let’s say you’re a married taxpayer filing your 2013 income tax return jointly. Let’s say your combined taxable income is $85,000. You’re marginal income – your last taxable dollar – is being taxed at 25% for income earned above $72,501. If you don’t take advantage of any tax breaks (ignoring all other tax credits), your tax bill to Uncle Sam will be $13,108 ($9,982.50 + 25% x (85,000 – $72,500)).
However, if you plan ahead and allocate your earnings ahead of the time, the savings can really add up. For example, in the same example with taxable income of $85,000, if you claim the following tax breaks – $17,500 for your 401k, $2,500 for your FSA, $130 per month for driving in a commuter highway vehicle, $250 per month for parking, and $5,000 for your Dependent Care FSA – your total tax bill would be substantially lower because your marginal tax-bracket goes from 25% to 15%. Your tax bill is now $7,412 – a savings of $5,690. Not bad for expenses you’re already planning to pay for!
Are You Ready to Start Saving?
Taxes are consistently one of our largest ongoing expenses. It’s important we do everything we can to legally minimize our tax liability to maximize our income. Speak with your HR department today to see what pre-tax paycheck deductions are available.
The deadlines vary for the above-mentioned tax breaks; for retirement plans, you can likely increase contributions throughout the year. For the FSAs, you need to figure out your employer’s open enrollment period. It’s important to stay on top of these key dates, so you can plan your deductions for next year.
While you’re preparing this year’s taxes, already start thinking about next year. The more you plan ahead, the more likely you’ll pay less taxes over the long run.
Which workplace tax breaks are you taking advantage of?