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6 Ways to Save Taxes in 2009

Finding ways to reduce your taxes is one of the easiest ways to cut your cost of living. Start thinking now about ways to reduce your 2009 tax bite. The following suggestions could help you reduce your income taxes by $1,000 or more. 

1. Contribute to retirement savings plans. If you can afford it, increase the percentage of your income that you contribute to your company retirement savings plan, such as a 401(k) or 403(b) plan, etc. This is the top tax-saving rule for all working-age people. Not only do you save taxes this year since the money you contribute probably isn’t subject to income taxes, but you also save taxes every year thereafter as the money accumulates tax-deferred. Even when you don’t receive a current tax deduction (such as a Roth IRA contribution), you’ll still enjoy lower taxes in the future.

2. Buy a home. One ofthe tax benefits of home ownership is being able to deduct mortgage interest and property taxes. This can often allow renters to buy a home that doesn’t cost a whole lot more than what they pay in rent, particularly now when housing prices are so depressed. In addition to the traditional tax breaks, a tax credit of up to $8,000 is available for qualified first-time homebuyers who purchase a principal residence on or after Jan. 1, 2009, and before Dec. 1, 2009. A tax credit is a dollar-for-dollar reduction in your income taxes.

Speaking of tax credits, a variety of additional credits may be available this year if you purchase a hybrid car or if you make energy-saving home improvements.

3. Make tax-wise charitable contributions. Charitable contributions are often made at the end of the year, but you may want to consider making some contributions earlier since so many worthy charities are hurting financially from the recession.

Cash is gratefully received, but you should also donate any usable but unneeded clothing and furniture. If you donate appreciated stock that you’ve held for a least one year, you get a deduction for its full value without having to pay a tax on the gain.

Finally, if you can afford to donate at least $10,000 in cash or appreciated securities, you can receive a lifetime annuity income as well as a partial tax deduction for the amount donated. These are called “charitable gift annuities,” and if you call your favorite charities to inquire, they’ll be more than happy to fill you in on the details.

4. Make the most of your employer’s fringe benefits. Employer fringe benefits are almost always tax-free, and your employer may offer a variety of benefits, including flexible spending plans and pre-tax commuting benefits.

5. Own a business.While you shouldn’t start a business solely for the tax breaks, many disillusioned workers and recent retirees are considering starting a full-time or sideline business.

If you ever own a business, you’ll be glad to know that the tax regulations bestow many tax blessings on small-business owners, including some very generous retirement savings plans. For example, a so-called “self-employed 401(k) retirement plan” allows a business owner to contribute and deduct up to 100 percent of the first $15,000 of self-employment income. Make that 100 percent of the first $20,000 for taxpayers who are 50 or older.

6. Forego your 2009 RMD if you can afford to. If you are older than 70 1/2 this year and have the resources to pay your living expenses without having to tap into your IRA money, you don’t have to make a required minimum distribution (RMD) from your IRA in 2009. Not only will this reduce your 2009 tax bite, but it could also prevent your having to sell IRA investments at a loss. By the way, the same rules apply if you have an inherited IRA.Unfortunately, if you have already made an RMD this year, you probably can’t undo it unless it was made in the past 60 days. If so, you should be able to put the money back into the IRA because of the 60-day rollover rules that allow such transactions without penalty. This privilege is available only once per year, however.

In 2009 and later, retirees who have money in both retirement and non- retirement accounts should adhere to the following rules of thumb:

  • Withdraw already-taxed (non-retirement) money first.
  • Withdraw retirement account money last.
  • Here’s an example that shows how well this strategy can work.

Tad and Tara Taxsavvy both just retired and are trying to figure out the best way to withdraw the $40,000 that they estimate they’ll need for living expenses during their first year of retirement. They have $650,000 in retirement accounts and $350,000 in brokerage accounts and CDs.

They first asked their lifelong friends, Ollie and Olivia Overpayer, for advice since the Overpayers had retired several years earlier. Ollie said: “This is a no-brainer. You should take all of your retirement money out of your retirement accounts. That’s what they’re for—retirement.” But Tad and Tara put pencil to paper and came up with this analysis: 

 

IRA Account

Maturing CDs

Amount of Withdrawal

$53,000

$40,000

Subtract income taxes (25% on retirement accounts)

-$13,000

     0

Amount available for living expenses

$40,000

$40,000

Here’s how Tara explains it: “Ollie’s right. This is indeed a no-brainer decision, but he’s got it backward. Since withdrawals from retirement plans are taxed, in our tax bracket we’d have to withdraw $53,000 from our IRA accounts and then pay out a whopping $13,000 in income taxes— leaving us with the $40,000 we need.

On the other hand, since our CDs aren’t in a retirement account, we can take $40,000 from them and not owe any taxes. Even if we withdrew money from our brokerage account investments, we’d only have to pay a small capital gains tax on the stocks in the account. So, we’re going to fund our first few years of retirement out of our already-taxed money, leaving the IRAs alone so that they can grow tax-free until we have to begin taking distributions.

All the information presented on AARP.org is for educational and resource purposes only. We suggest that you consult with your financial or tax adviser with regard to your individual situation. Use of the information contained in this Web site is at the sole choice and risk of the reader.

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