Navigating the Inflation Landscape: Tax Planning Strategies for 2024

The inflation rate has precipitously dropped from the forty-year highs we saw in 2022, but it remains elevated. While we are seeing the relief on prices, incorporating tax planning can reveal some positive impacts of higher inflation.

The IRS links tax brackets, deductions, and retirement savings contributions like 401(k)s to inflation, allowing for increased retirement savings, reduced taxes, and higher earnings without shifting into a higher tax bracket. Despite expected decreases in inflation, changes in tax brackets, standard deductions, and contribution limits are likely to remain permanent.

What Strategies Should Individuals Consider When Tax Planning in 2024 with Inflation in Mind?

As an investor in municipal bonds, it is crucial to consider tax planning strategies that take into account the potential impact of inflation in the year 2024. Inflation can erode the purchasing power of the returns generated from your investments. However, with careful planning and an understanding of the various strategies available, you can optimize your tax position and mitigate the effects of inflation.

1. Utilize Tax-Advantaged Accounts: One effective strategy to mitigate the impact of inflation on your investments is to utilize tax-advantaged accounts such as individual retirement accounts (IRAs) or 401(k)s. Contributions to these accounts enjoy tax-deferred status, allowing your investments to grow without facing annual income taxes. By deferring taxes until you withdraw funds in retirement, you can potentially reduce the impact of inflation on your taxable income.
2. Consider Municipal Bond Investments: Municipal bonds, issued by state and local governments, offer tax advantages. Interest income from these bonds is often exempt from federal and sometimes state and local taxes. Investing in municipal bonds can lower your tax liability and protect returns from inflation.
3. Focus on Tax-efficient Investments: When planning for taxes in 2024, it is important to focus on tax-efficient investments. This means considering investments that generate income in a way that minimizes your tax liability. For example, investing in tax-efficient index funds or low-turnover mutual funds can help reduce the number of taxable events within your portfolio. Additionally, considering tax-managed funds or tax-exempt bond funds can further optimize your tax position and mitigate the impact of inflation.
4. Take Advantage of Tax-Loss Harvesting: Tax-loss harvesting is a strategy that involves selling investments that have experienced a loss in order to offset any capital gains you may have realized. By strategically harvesting losses, you can potentially reduce your overall tax liability and maximize your after-tax returns. This strategy can prove particularly useful in a year with elevated inflation, as it lets you offset any gains that rising prices may have eroded.
5. Consult with a Tax Professional: Tax planning, especially with inflation in mind, can be complex. Consulting with a professional specializing in tax-efficient strategies and municipal bonds is advisable. They offer personalized advice to align with your financial goals.

Higher Tax Brackets Can Help You Plan a Multi-Year Strategy

Tax brackets are pegged to inflation to ensure that they reflect real income. Inflation reduces the value of tax credits and exemptions, which means you pay more taxes. Increasing the income range in each tax bracket means the system may tax more income at lower 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 take large amounts of taxable income in years in which all income may be lower.

Considering income sources, tax impacts of asset sales, capital gains, and other taxable events can aid in creating a multi-year strategy. The aim is to minimize lifetime taxes, not just annual ones, whether working or retired.

The Standard Deduction Increase is Meaningful

The federal standard deduction will increase to $14,600 next year, from $13,850 in 2023, for single files. 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, it may make sense to itemize. But it’s worth doing the calculation to find out.

You do have an option for charitable gifts that can increase the amount you can deduct. You can “bunch” your charitable gifts that are intended for several years into a single year. This strategy can be effective when all your itemized deductions, including the bunched gifts, are more than 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, also the Thrift Savings Plan for federal government employees.

IRA limits 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 $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 age 50+ remains the same at $1,000. These accounts are referred to as “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 also not taxed.

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. If you’re working while collecting social security, 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 this year is $22,320.

If you’re still paying into the system, you may be paying a bit more next year. 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

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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Disclosures:
This commentary is not a recommendation to buy or sell a specific security. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation. Investing involves risk including possible loss of principal. Past performance is no guarantee of future results.