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Three hidden tax mistakes to avoid

January 25, 2021

We all have a lot on our minds as we enter the new year: COVID and how it has affected all our lives, possible financial insecurity or hardship, political polarization and changing leadership in Washington, D.C. But let’s accept the fact that tax season is upon us.

With that in mind, here are three tax-planning missteps I often see clients make, and how you can avoid them in your own financial life.

1. Having too much tax withheld from your paycheck: According to IRS data, nearly 75 percent of Americans received tax refunds in 2019, with the average refund totaling just over $3,000. Many taxpayers appreciate receiving a windfall each spring, but having too much tax withheld from your paychecks is like giving the U.S. government an interest-free loan until you receive your refund. In a perfect world, your withholding amounts would equal your tax liability for the year, resulting in neither a tax bill nor a refund. It’s hard to get it exactly right, but the IRS Tax Withholding Estimator can help calculate whether you should adjust your withholding.

2. Letting taxes eat into your returns: A dollar saved from taxes isn’t just a dollar earned; it’s a dollar that can continue to potentially grow over time thanks to the power of compounding. That’s why you must be especially careful when it comes to your taxable brokerage and savings accounts, because over time, taxes can have a huge effect on your after-tax returns.

It’s often best to hold tax-inefficient investments in tax-deferred accounts like 401(k)s and IRAs. Conversely, it can be best to hold assets that tend to lose less of their returns to taxes, such as municipal bonds or exchange-traded funds, in a taxable brokerage account.

3. Going it alone: You may be capable of mastering the tax code on your own, but do you really want to? After all, there’s a world full of experts out there who can help ensure you pay your fair share but not a penny more – and who may even be able to help save you a bit of money in the process.

The goal here is to make tax preparation and planning less painful and ideally more productive for you. Get organized, ask questions, get help if you need it, and be proactive related to your 2020 tax filing. And while you’re at it, carry your new year’s motivation into your 2021 tax planning.

Mark E. Engberg, CFP, is a Charles Schwab independent branch leader in Rehoboth Beach. Engberg is an Eastern Shore native and has 20 years of experience helping clients achieve their financial goals. Engberg and Stephanie Brown, MBA, independent financial consultant, offer a free, no-obligation consultation and portfolio review. Engberg and Brown can assist clients remotely; they have many tools and resources to help investors take charge of their financial future and own their tomorrows. For more information, go to schwab.com/rehobothbeach.

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