If you’ve seen a wage increase this year, congratulations! However, there might be a downside to that extra cash. Your new paycheck could push you into a higher tax bracket—a situation known as tax-bracket creep. Tax-bracket creep occurs when wages rise due to inflation, pushing individuals into higher marginal tax brackets, potentially increasing their tax bills. This phenomenon can be especially frustrating as rising costs already squeeze budgets.
While the federal government adjusts tax brackets annually for inflation, various credits, deductions, and surcharges don’t always receive the same treatment. This could lead to higher effective tax rates, whether you take the standard deduction or itemize. For example, the Net Investment Income Tax (NIIT) remains unchanged and imposes a 3.8% surtax on capital gains, dividends, and interest income if your modified adjusted gross income surpasses certain thresholds ($200,000 for single filers, $250,000 for married couples). As housing prices rise and interest rates increase bond and CD yields, it’s critical to plan for these taxes.
To help you keep more of your hard-earned money and avoid the pitfalls of tax-bracket creep, here are eight strategies you can consider to reduce your taxable income and potentially lower your tax bill:
1. Maximize Retirement Contributions
One of the simplest and most effective ways to reduce your taxable income is by maximizing contributions to tax-advantaged retirement accounts. For 2024, you can contribute up to $23,000 to your 401(k) if you have a workplace retirement plan, and individuals aged 50 and above can make additional catch-up contributions of $7,500. For IRA contributions, the limit is $7,000 in 2024, with an additional $1,000 catch-up contribution for those 50 and older.
Since contributions to traditional 401(k)s and IRAs reduce taxable income on a dollar-for-dollar basis, this strategy can potentially move you into a lower tax bracket. Not only does this help you save for retirement, but it also shields some of your income from taxes today.
Traditional IRA deduction limits
| 2024 IRA deduction limit — You are covered by a retirement plan at work | ||
|---|---|---|
| Filing status | Modified adjusted gross income (MAGI) | Deduction limit |
| Single individuals | ≤ $77,000 | Full deduction up to the amount of your contribution limit |
| > $77,000 but < $87,000 | Partial deduction | |
| ≥ $87,000 | No deduction | |
| Married (filing joint returns) | ≤ $123,000 | Full deduction up to the amount of your contribution limit |
| > $123,000 but < $143,000 | Partial deduction | |
| ≥ $143,000 | No deduction | |
| Married (filing separately)1 | < $10,000 | Partial deduction |
| ≥ $10,000 | No deduction | |
Source: “401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000,” Internal Revenue Service, November 1, 2023.
| 2024 IRA deduction limits — You are NOT covered by a retirement plan at work | ||
|---|---|---|
| Filing status | Modified adjusted gross income (MAGI) | Deduction limit |
| Single, head of household, or qualifying widow(er) | Any amount | A full deduction up to the amount of your contribution limit |
| Married filing jointly with a spouse who is not covered by a plan at work | Any amount | A full deduction up to the amount of your contribution limit |
| Married filing jointly with a spouse who is covered by a plan at work | $230,000 or less | Full deduction up to the amount of your contribution limit |
| > $230,000 but < $240,000 | A partial deduction | |
| ≥ $240,000 or more | No deduction | |
| Married filing separately with a spouse who is covered by a plan at work | < $10,000 | Partial deduction |
| ≥ $10,000 | No deduction | |
Source: “401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000,” Internal Revenue Service, November 1, 2023.
2. Remember Your Health Savings Account (HSA)
If you’re enrolled in a high-deductible health plan (HDHP), consider maximizing contributions to a Health Savings Account (HSA). For 2024, you can contribute up to $4,150 if you’re an individual, or $8,300 for family coverage. Those 55 and older can also make an additional $1,000 catch-up contribution.
An HSA offers triple tax benefits: contributions are tax-deductible, growth on investments within the HSA is tax-free, and withdrawals for qualified medical expenses are also tax-free. By contributing to an HSA, you can reduce your taxable income while preparing for future healthcare costs.
3. Defer Payouts and Payments
If you’re facing significant gains this year—perhaps from selling a house, receiving severance, or selling stock—it may be worth deferring income or payments into the following year. Doing so can help prevent your income from creeping into a higher tax bracket. For example, spreading the sale of stock over two years can prevent a substantial capital gain from bumping you into a higher bracket or triggering the NIIT surtax.
Additionally, if you’ve recently sold a home, you can exclude up to $250,000 in capital gains ($500,000 for married couples) from your taxable income, provided you meet certain conditions, such as having lived in the home for two out of the last five years. Keep detailed records of any capital improvements to your property, as these increase your cost basis and reduce taxable gains.
4. Make the Best Use of a Roth Conversion
A Roth IRA conversion allows you to transfer funds from a traditional IRA into a Roth IRA, and while the conversion amount is taxable, it provides tax-free growth and distributions in retirement. This can be an excellent strategy if you anticipate being in a higher tax bracket during retirement or if you want to reduce your required minimum distributions (RMDs), which begin at age 73 for traditional IRAs.
The key to a Roth conversion is timing. If you expect to be in a lower tax bracket this year, converting a portion of your traditional IRA could be beneficial. However, consult with a tax advisor to avoid bumping yourself into a higher tax bracket unintentionally.
5. Engage in Tax-Loss Harvesting
Tax-loss harvesting involves selling investments that have declined in value to offset gains from other investments. You can use these losses to offset up to $3,000 of ordinary income each year, depending on your filing status. If you’re holding onto investments that are below their cost basis, consider selling them to realize a loss, then reinvest in a similar asset to stay aligned with your long-term investment strategy.
Beware of the wash-sale rule, which disallows a deduction if you repurchase the same or substantially identical investment within 30 days. Always consult with a tax professional to ensure you’re using this strategy effectively.
6. Optimize Asset Location
Asset location is a strategy that involves placing investments in the most tax-efficient accounts. Certain investments, like bonds and bond funds, generate ordinary income, which is taxed at higher rates than long-term capital gains or qualified dividends. By holding these tax-inefficient investments in tax-advantaged accounts, like IRAs or 401(k)s, you can defer taxes or avoid them altogether if held in Roth accounts.
On the other hand, more tax-efficient investments, like stocks that generate qualified dividends, are often better suited for taxable brokerage accounts. This strategy can help you maximize after-tax returns.
7. Utilize Qualified Charitable Distributions (QCDs)
For retirees who are required to take RMDs from their traditional IRAs, a qualified charitable distribution (QCD) can be a tax-efficient way to give to charity. A QCD allows you to donate up to $105,000 ($210,000 for couples filing jointly) directly from your IRA to a qualified charity. This counts toward your RMD but isn’t subject to federal taxes, reducing your taxable income without needing to itemize deductions.
QCDs are available once you reach age 70½, providing an opportunity to reduce your tax burden even before RMDs begin.
8. Bunch Charitable Contributions
If you’re close to the threshold for itemizing deductions, consider “bunching” your charitable contributions by concentrating donations into a single tax year. This strategy allows you to itemize your deductions that year while taking the standard deduction in future years. You can also use a donor-advised fund to make a charitable donation now, take the deduction, and distribute the funds to charities over time.
Additionally, itemizers can donate appreciated assets held for over one year to avoid paying capital gains taxes and deduct the fair market value of the donation. This can further reduce your taxable income and provide a meaningful charitable gift.
Final Thoughts
Inflation may be easing, but tax-bracket creep remains a real threat for many households. With wages rising and the cost of living still elevated, it’s more important than ever to be proactive in managing your taxable income. By maximizing retirement contributions, utilizing HSAs, deferring income, and strategically managing investments and charitable donations, you can effectively reduce your tax liability and protect your financial future.
As always, consult a tax professional or financial advisor to ensure that the strategies you choose align with your overall financial goals and tax situation.
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