This One Change Could Dramatically Lower Your Taxes

If you only make one tax-reducing move this year, be sure to maximize your contributions to tax-advantaged accounts. You don't need to be a tax guru to do this. As long as you understand what tax bracket you're in and what retirement contributions you're making, you could slash the amount you pay to Uncle Sam.

Contribute to tax-advantaged accounts

Tax-advantaged accounts can be a great way to lower your tax bill. Let's say you're a 45-year-old single taxpayer who does not pay into a company retirement plan. If you earn $60,000, you'd be in the 22% tax bracket. By putting $6,500 into a tax-deferred account such as a traditional individual retirement account (IRA), you could cut your 2023 tax bill by $1,430.

The good news is that, unlike other ways to cut your taxes, you can do this right up until the April 15 tax deadline. Here are some common tax-advantaged accounts to consider.

1. Traditional and Roth IRA accounts

IRA contributions are a popular way to reduce your tax liability. There are several different types, but the most common are traditional and Roth IRAs.

Here's how they work:

• Traditional IRA: Payments to a traditional IRA can reduce your taxable income now. You will pay taxes on the money when you take it out in your old age. Check out our best IRA accounts.
• Roth IRA: A Roth IRA won't reduce your tax bill today, but could lower your taxes later in life. You contribute after-tax dollars and then withdraw money tax-free once you've retired. Check out our best Roth IRA accounts.

The biggest downside to IRA contributions versus putting money into a brokerage account is that you can't easily get at those funds until you're 59 1/2. There are also limits on how much you can put into IRAs. The total contribution you can make to your traditional and Roth IRAs combined is $6,500 for the 2023 tax year, or $7,500 for those over age 50.

Actionable takeaway

Use an IRA calculator, tax software, or a financial advisor to work out how much you might contribute to an IRA and which account type makes the most sense for you. It's also worth finding out if you qualify for the saver's credit.

The saver's credit could be worth $1,000 ($2,000 for married couples)

If you earn less than $36,500 as a single filer or $73,000 as a married couple in 2023, you could earn a tax credit by making retirement contributions. The credit amount depends on how much you put into retirement accounts and how much you earn.

While the tax reductions mentioned above reduce the income you pay tax on, a tax credit directly reduces your tax bill. So if you owed $5,000 in taxes and qualified for a $1,000 credit, your bill would shrink to $4,000. It is a non-refundable credit, so it won't take your bill below zero.

2. Health savings account (HSA)

If you have a high-deductible health plan, you may be able to reduce your tax bill by putting money into your HSA. You can invest the money in it, and there are no rules that say you have to use it within a certain timeframe.

There are three tax advantages to HSA contributions:

1. You won't pay taxes on the money you contribute.
2. You won't pay taxes on any interest or returns you earn.
3. You won't pay taxes when you take the money out, as long as you use it for medical expenses.

HSAs aren't for everybody. For starters, you need to have an HSA-eligible health plan. These come with high deductibles, which can translate to lower monthly premiums. The idea is that you put money into an HSA so you can pay higher upfront costs when needed.

This type of account may not make sense if you regularly visit the doctor or need medical care. If you're enrolled in Medicare or covered by a spouse's medical plan, you won't qualify for an HSA.

Actionable takeaway

Find out whether you're eligible to make HSA contributions and whether this type of health insurance might make sense for you. You can open an HSA with many banks and stock brokers. If your health insurance comes through work, talk to your HR department.

The maximum individual contribution to an HSA for the 2023 tax year is $3,850. The family coverage maximum is $7,750.

Understanding 401(k)s

If your company offers a 401(k) plan, it does reduce your tax bill, but it isn't the same as, say, an IRA. The money is taken out of your paycheck directly so you can't use contributions to reduce your tax bill now. The contribution limits are much higher, and some employers will match what you put in.

You can have an IRA and a 401(k). But if you or your spouse are contributing to a work 401(k), you may not be able to claim the full IRA tax deduction. For example, a single filer who has a work retirement plan and earns more than $73,000 would only get a partial IRA tax deduction on the 2023 tax year.

Bottom line

With a bit of planning, there are lots of ways to reduce your tax bill, leaving you more money for other financial goals. But with tax season just around the corner, your options are more limited. Find out if maxing out your tax-advantaged contributions today could dramatically lower your 2023 tax bill.