As we look ahead to the next tax season, here are five strategies an investor can use throughout the year to help lower their tax bill. These strategies are:

• threshold planning
• income exclusions
• capital gains management
• bunching of itemized expenses
• health savings account (HSA) contributions

Investors may choose to use one or more of these strategies, depending on their situation. They may also wish to partner with an advisor who can build these strategies into their personalized financial plans. 

Threshold planning aims to keep investors within a target tax bracket. Depending on an investor’s goals and situation, it may make sense for them to decrease, defer, or accelerate their income.

• Lowering income can be accomplished by deferring income into traditional IRAs and 401(k) plans. Investors can also look for income sources that are excluded from federal income tax.
• Accelerating income can be achieved by taking retirement plan distributions and increasing allocations to a Roth account within those plans. Investors can also harvest gains from their taxable accounts.

“Investors should take a long-term, disciplined approach to tax planning,” said Ashley Greene, a Vanguard wealth planning specialist and co-author of the recent research paper Fundamentals of Tax Planning: Going Beyond the Basics (18-page PDF). “When considering all the taxes you pay over time, paying increased taxes today may net you the optimal results over the course of your lifetime.”

As we’ve noted, one of the ways to keep within a target tax bracket is to look for income sources that can be excluded. Two such sources are:

• Municipal bonds. Switching from taxable corporate bonds into tax-free municipal bonds can lower an investor’s tax bill. Keep in mind that municipal bonds often pay less interest than equivalent corporate bonds. For this reason, it’s important to compare municipal and taxable bonds on an after-tax basis.
• Roth accounts. Although Roth contributions won’t lower an investor’s taxable income in the short term, they can provide additional flexibility for long-term threshold planning.

Managing capital gains involves looking for ways to streamline taxable account transactions. This can be done by using rebalancing proceeds or fund distributions to fulfill future cash-flow needs, reposition a portfolio, or meet gifting needs. Investors should pay particular attention to default settings for reinvestment, cost basis, and rebalancing, as those can have significant tax consequences.  

One way to maximize annual itemized deductions while planning over a multiyear horizon is to use a bunching strategy. This entails shifting the payment of multiple years’ worth of deductible expenses into a single year. Bunching is primarily used for charitable contributions and medical expenses, but it may also be available for other expenses, depending on the laws of the state where the investor files their taxes. 

For a short-term boost to total deductions, investors should consider contributing to an HSA if one is available. Health care expenses are an itemized deduction to the extent they exceed 7.5% of the investor’s adjusted gross income. HSA contributions, though, are fully deductible in the year they’re made. Contributing to an HSA to cover short-term expenses can convert nondeductible, out-of-pocket medical expenses into deductible HSA contributions.¹

“HSAs offer immediate tax-planning benefits that are often overlooked,” Greene said. “HSA contributions are considered above-the-line deductions, which are deducted from your income and can help reduce taxable income. By shifting the cost of medical expenses from an itemized deduction to an above-the-line deduction, you reduce taxable income and the amount of taxes owed.”

Investors may find some of these strategies a bit complicated to manage on their own. If so, they may want to consider working with an advisor who can help navigate the complexities—and lower their tax bill.

• SECURE 2.0—What’s new in 2024 (article, issued January 2024)
• Fundamentals of tax planning: Going beyond the basics (18-page PDF, issued August 2023)
• Income-driven financial planning may help reduce taxes (article, issued August 2023)