Many people never think about their taxes until April rolls around, but by then, it's too late to take full advantage of all the opportunities to cut your tax bill. By looking at some simple tax moves before the last minute, you can put yourself in much better position to pay less on your taxes year in and year out. Below, you'll find five ideas on how you might be able to be tax-smart in 2016.
1. Use all the tax-advantaged accounts at your disposal.
The most valuable way to cut your tax bill is to take full advantage of the opportunities the IRS gives you to shelter money from taxation. Most people understand that IRAs, 401(k) plans, and other retirement accounts are eligible for favorable tax treatment, ranging from tax-deferred growth for traditional IRAs and 401(k)s to tax-free treatment for Roth retirement accounts. But many people don't realize that there are other ways to save on taxes.
For instance, workers who have access to flexible spending accounts can put pre-tax money aside for medical or child care expenses and then withdraw the money to pay them throughout the year on a tax-free basis. Moreover, those who have high-deductible health insurance plans can open health savings accounts, which let you make tax-deductible contributions and then spend the money and any earnings tax-free as long as it goes toward medical expenses. Don't leave any stones unturned in your quest for tax savings.
2. Remember your kids.
If you have children, then saving for their future can also give you tax benefits. 529 plans and Coverdell Education Savings Accounts let you save money on a tax-deferred basis and then take withdrawals tax-free for use for eligible educational expenses. Custodial accounts for your children don't share the same tax benefits, but each child can have up to $1,050 in investment income tax-free and another $1,050 taxed at their own tax rates before the kiddie-tax provisions kick in to increase their tax rate to match yours. You have to consider some financial control issues, but you can save on taxes if you're comfortable setting things up the right way.
3. Look at index investments for your fund holdings.
If you use mutual funds or ETFs to invest, think twice before you use an active manager. Not only have actively managed mutual funds tended to underperform their index-driven counterparts, but they also tend to be less tax-efficient. That's because active managers buy and sell their holdings more often than index managers change the components of their respective indexes, and that results in greater capital gains activity among active funds. Most ETFs track indexes, and their structure lends itself to minimal tax impacts from other traders, making them ideal investments from a tax perspective.
4. Hold your stocks longer.
Many people think that investing involves making quick scores and getting out before profits disappear. But a short-term focus can be costly at tax time, because short-term gains get taxed at rates anywhere from 10 to 20 percentage points higher than long-term capital gains. You only have to hold onto an investment for a year and a day in order to get long-term treatment, and since you don't have to pay any tax at all until you actually sell your shares, there's a huge tax incentive to become a long-term investor.
5. Plan things early.
Waiting until the last minute leaves you in the herd of most taxpayers, and that can create problems. For instance, if you wait until November or December to do tax-loss harvesting, then you typically end up selling shares at a time when they're at their weakest, exacerbating losses. By contrast, if you sell earlier, you can beat the crowd -- and also put yourself in position to buy those shares back at cheaper prices when selling pressure reaches its climax late in the year. Similarly, the sooner you make retirement contributions, prepare for deductible expenses, or look up what you have to do to be eligible for credits and other tax breaks, the easier it is to put your strategy in motion without worrying about deadlines.
Make 2016 the year you finally make good on your resolution to get your taxes dealt with sooner rather than later. By accelerating your tax planning, you can get more savings and feel more confident that you're paying no more in taxes than you absolutely have to pay.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.