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- Instead of spending the interest from your savings account, save it for taxes.
- I like putting money into CDs, and one option that helps with tax planning long term is a SEP IRA CD.
- I pay attention to when the CD matures so that the tax consequences are spread out over multiple years.
One of the biggest financial mistakes I made for 10 years was putting all my cash in low-interest savings accounts. I was earning little interest each year and was missing out on the potential for that idle capital to grow exponentially.
In 2022, I decided to proactively optimize where my cash is sitting at all times. I started moving money between high-yield savings accounts, CDs, and other passive income-producing investments like his REITs and dividend stocks.
You could earn anywhere from a few hundred dollars to a few thousand dollars a year in interest. It felt good to be able to make money without doing much and without taking big risks, but it also had its pitfalls. Interest and earnings from savings accounts, CDs, and other investments are considered taxable income.
I didn’t realize it at first and spent much of this passive income on vacations, building my business, and paying off my credit cards. But after being hit with a high tax bill in 2023, I decided to be more strategic about the tax implications of moving funds between accounts to optimize interest. . Here’s how I planned his 2023 tax bill.
1. Don’t spend interest immediately after receiving it
When my accountant told me how much tax I would owe in 2022, I was convinced she had made a mistake. But she said the reason my bill was so high was because I earned a lot of interest from a high-yield savings account and didn’t pay taxes on that income throughout the year.
Since most of that money was spent or reinvested in my business, I decided to stay away from it until after tax season. It helped me rebuild my finances. They don’t think they have thousands of dollars to spend throughout the year and don’t consider that income as part of their overall net worth. Instead, reevaluate how much interest income you actually earned after paying taxes and decide what to do with the cash at that time.
2. I use interest to pay taxes
As a sole proprietor, I pay both corporate and personal tax each year. Even though my accountant and I each withhold taxes from our paychecks, pay quarterly taxes, and make sure to make estimated tax payments, we still end up paying thousands of dollars in taxes each year.
I don’t like using my personal savings to pay this tax, so I often look at the interest and income I earn from money transfer strategies and passive income investments as a way to cover the tax. I now wait until I know how much my taxes will be before paying that money, and I often use at least half of that money to cover the entire bill.
3. Buy some SEP IRA CDs.
Storing cash in high-interest CDs is a big part of my money strategy. When I have a good month and have extra money coming in, or when the interest rate on my high-yield savings account goes down, I put that money into various types of CDs.
One tax-advantaged CD is the SEP IRA CD, which is considered a retirement investment account. The interest earned on the money in this CD is tax deferred until distributions are made in retirement. However, unlike regular CDs, retirement fund CDs have contribution limits set by the IRS.
4. I use short-term CDs strategically.
As a sole trader, my income fluctuates considerably throughout the year. I plan to talk to my accountant around November and come up with a plan to lower my overall tax bill if my income is higher than usual. One strategy I’ve used in the past is to buy short-term CDs with expirations in January or February of next year. This allows you to defer taxes on that money until the following year, when your taxable income may be lower.
