Tax season has started for computing and filing your 2024 taxes. While you do that, it is not too early to start planning ahead to make smart tax moves in 2025. Forward looking tax planning can help you save on taxes and potentially build more wealth in the long run. You can start with these five tax planning tips for employees in 2025.
As always, with these types of tax planning tips, make sure to do your own research and consider consulting with an advisor before applying these ideas to your individual situation.
Five Tax Planning Tips For Employees
- Max out your 401k early.
- Take advantage of extra 401k catch-up contributions if you’re aged 60-63.
- Consider bundling your donations.
- Adjust your tax withholding.
- Taxable or tax exempt bonds?
Max Out Your 401k Early
There are a couple of potential advantages of maxing out your 401k early.
The first is that while you may plan to be at your employer all year, there are no guarantees. You may decide to take some time off, retire early, or your position could be eliminated. If you had been spreading out your 401k contributions throughout the year on each paycheck and are laid off in March, you may end up missing out on most of the tax benefits of your 401k contribution this year.
By maxing out your contributions early, you ensure that regardless of what the rest of the year holds you have secured these 2025 401k tax benefits.
The second is that it will give your funds more time in the market. Because the stock market goes up on most days having more time in the market will allow more of your investment funds to be working for you earlier in the year.
This is by no means a guarantee of a higher return. You could get unlucky and there could be a bear market or correction later in the year. However, historically in most time periods the earlier you begin investing the better.
Before maxing out your 401k early make sure that your plan offers a “true-up” of the company match at the end of the year so that you do not miss out on this benefit. You can find this information in your plan document or by asking your benefits administrator. If the plan does not offer a true-up you are better off spreading your contributions over the year.
To implement this, raise your 401k contribution percentage as high as your cash flow needs will allow until you have reached the maximum salary deferral limit of $23,500 in 2025. Employees aged 50 and over can contribute up to $31,000, and even more if you are aged 61-63!
Take Advantage of Extra Catch-up Contributions for Aged 60-63
As part of the Secure Act 2.0, additional 401k catch-up contributions were authorized for 2025. If you will be aged 60 to 63 during this tax year you can save an additional $11,250 over the base amount of $23,500 for a total contribution of $34,750.
Taxpayers over 50 but outside of the 60-63 age bracket also get a catch up contribution of $7,500.
These are savings that you can do as an employee via salary deferral and do not count any contributions your employer makes on you behalf such as a company match.
These 401k salary deferrals can be contributed to a Pre-tax 401k or Roth 401k (if your plan allows.) I’ve written about Pre-Tax vs. Roth 401k contributions here.
Consider bundling donations
Contributions you make to charity are tax deductible but only if you itemize deductions. For 2025 the standard deduction is a nice round $15,000 for single filers and $30,000 for married filing jointly. You will only see a tax benefit from your donations if your total itemized deductions are above this threshold.
For most taxpayers, other itemized deductions that would count towards this limit are mortgage interest on your primary home, and up to $10,000 of state and local taxes. So, if you have no mortgage interest and $10,000 of property taxes, you would need to donate $20,001 (if married filing jointly) to begin to see extra tax savings from your charitable activity.
With this higher standard deduction, one strategy is to contribute multiple years worth of donations for a single year of tax benefits.
For example, let’s say you are a single filer with $6,000 of mortgage interest and $4,000 of state and local taxes. If you normally would donate $5,000 to your church you will end up right at the $15,000 standard deduction amount and not get any tax benefit from this donation.
Instead, if cash flow allows, donate $10,000 to your church this year. This will result in $5,000 of extra tax deductible charitable contributions since you are now itemizing deductions. You would then skip the donation next year and take the itemized deduction. Even though you only would have $10,000 of itemized deductions next year, you will still get the benefit of the extra $5K through the $15,000 standard deduction.
But wait, is this the best thing for the church? The church may be counting on having those steady $5,000 annual tithes coming in. Aren’t you adding an unnecessary cash-flow management burden onto your church?
A great tool to fix this dilemma is a Donor Advised Fund (DAF). A DAF is a charitable fund that can be contributed to in a lump sum. You can then advise the fund on where to disperse the donations in your account. A DAF separates the timing of the tax benefits, from the timing of the donation to your ultimate charity.
With a DAF you can also facilitate donating stock and other property, which may be advantageous itself! I have written about donating stock and DAFs here.
Adjust your withholding
Did you just do your 2024 taxes and get a big refund? That’s great, but you essentially just let the IRS hold onto your money for a year without them paying you any interest.
Employees, consider filling out a new W4 form to adjust your withholding and increase your take home pay now, rather than waiting for another refund next year.
Self-Employed taxpayers can adjust their estimated tax payments based on their income projection for 2025. The first estimated tax payment for this tax year is due April 15, 2025.
Would you be better off in taxable or tax-free bonds?
It’s great news that cash and fixed-income have been offering higher yields than they did for much of he past decade. There is a tax dimension to this that should be considered as well.
Traditional money market funds, and most fixed income (Treasuries, corporate bonds, etc.) generate taxable interest. This interest is taxable at your full marginal tax rate. This is the case even in a fund that distributes the interest as fund “dividends”. There is no special tax treatment for these dividends like there is for the qualified dividends of common stocks.
There is also a class of fixed income (and money markets) interest that is exempt from Federal income tax. These are the bonds issued by state and local municipalities, school districts, and in some cases public utilities. Usually bonds issued by your state of residence will also be free of state income tax.
Due to the tax benefits, these municipal bonds tend to carry a lower interest rate than taxable bonds of a similar risk level.
To figure out if it makes more sense to invest in taxable or tax-free bonds you need to calculate your tax equivalent yield. This is done by subtracting your percentage tax bracket from one and then dividing the result into the percentage interest rate of the tax-exempt bond.
You can then compare the tax equivalent yield of the municipal bond to the yield on the taxable bond you are considering.
So if you are in the 24% tax bracket and you are considering a municipal bond with a yield of 2.7% your tax equivalent yield would be 3.6%. In other words, you would need to earn more than a 3.6% yield on your taxable bond to be better off after receiving the higher yield and paying tax on the income.
If you have any questions about these five tax planning tips for employees in 2025 you can contact me here. I check this email on most weekdays and try to respond to all readers.
