The inflation rate has come down from the forty-year highs we saw in 2022, but it is still high. While we are witnessing relief in prices, higher inflation has some positive impacts.
The IRS sets tax brackets, tax deductions, 401(k), and other tax-efficient retirement savings account contribution amounts by pegging them to inflation. These changes in contribution limits mean you can increase retirement savings, reduce your tax burden, and earn more without moving into a higher tax bracket. And while inflation may continue to decrease, the tax bracket and standard deduction changes and contribution limits are likely to be permanent.
Now is the time to begin your 2024 tax planning.
Higher Tax Brackets Can Help You Plan a Multi-Year Strategy
Inflation reduces the value of tax credits and exemptions, which means you pay more taxes. To offset this, tax brackets are pegged to inflation to ensure that they reflect real income. Increasing the income range in each tax bracket means more income may be taxed at lower tax rates.
Planning to keep more of your income in the lowest possible brackets can save you considerably on taxes. It requires a multi-year plan to consider all sources of income and a strategy to handle large amounts of taxable income in years in which all income may be lower.
Thinking through sources of income, the tax impacts of more significant asset sales, capital gains taxes on investments, and other taxable events can help you devise a multi-year plan. The goal isn't just to lower taxes in any year but to reduce the amount you pay over your life, whether you are working or retired.
The Standard Deduction Increase is Meaningful
The federal standard deduction for single filers will increase to $14,600 next year from $13,850 in 2023. For married couples filing jointly, the new deduction amount is $29,200. If your mortgage interest, charitable contributions, and the allowable amount of state and local taxes are more than the new standard deduction, itemizing may make sense. But it's worth doing the calculation to find out.
You have an option for charitable gifts that can increase the amount you can deduct. You can "bunch" your philanthropic gifts intended for several years into a single year. This strategy can be effective when all your itemized deductions, including the bunched gifts, exceed the standard deduction.
Retirement and Healthcare Savings Contributions
Retirement savings contributions increased as well. The new maximum contribution limit is $23,000. If you are age 50 or over, you can take advantage of the "catch-up" contribution of $7,500, for a total of $30,500. The new limits don't just mean increased savings; they also lower your taxable income. The same limits apply to 403(b) plans, many 457 plans, and the Thrift Savings Plan for federal government employees. IRA contribution limits have also increased to $7,000. The catch-up contribution for an IRA for those age 50+ is an additional $1,000.
Flexible health spending accounts can now accept contributions of up to $3,200 of pre-tax dollars to this type of account to pay for medical costs that aren't covered by insurance.
Health Savings Accounts (HSAs) have new maximum contributions, too. An individual can contribute up to $4,150, and the family contribution has risen to $8,300. The catch-up amount for those aged 50+ remains the same at $1,000. HSAs are "triple-tax-advantaged" because you contribute pre-tax dollars that lower your taxable income in the year you contribute, the accounts grow tax-free, and qualified withdrawals are not taxed. Be sure to review your eligibility for making contributions to an HSA.
Social Security Benefits and the Earnings Test Went Up – But So Did Taxes
Social security benefits increased by 3.2%, a more normal increase than the big numbers we've seen for the last two years. The maximum monthly benefit for claiming at your full retirement age (FRA) will be $3,822 in 2024.
Suppose you're working while collecting social security and under FRA. In that case, your earnings are subject to an earnings test limit, above which annual benefits are reduced by $1 for every $2 in income over the limit. That limit for 2024 is $22,320. Now, suppose you're working while collecting social security and have reached full retirement age. In that case, your earnings are still subject to an earnings limit, above which annual benefits are reduced by $1 for every $3 you are over the limit. That limit is $59,520 for 2024.
You may pay more next year if you still pay into the system. Social security taxes are 6.2% of income, up to a maximum earnings ceiling. The limit increased to $168,600 in 2023. This translates to a dollar amount of $8,400.
The Bottom Line for 2024 Tax Planning
Taking advantage of the silver lining of inflation by maximizing tax-advantaged savings and undertaking proactive tax-planning strategies can help you keep your financial planning on track.
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