Every time you earn, spend, save, and invest your money there are tax implications. Almost every financial decision you ever make will be taxable.
Instead of waiting until April 15th to find out how each decision you made in the previous year hits your tax return, you can take a more strategic approach that allows you to capitalize on every option available to you. That approach is proactive tax planning.
A proactive tax plan is consistent with your goals both now and in the future, serving a supplementary role to your holistic financial and retirement plans. As a financial advisor in Bountiful, Utah, we find proactive tax planning to be one of the smartest investments you can make.
Proactive Tax Planning vs Reactive Tax Preparation
Tax planning is the analysis of your entire financial situation (income sources, expenses, investments, savings) with the goal of paying the lowest amount of taxes possible over your lifetime.
Since the IRS uses your AGI (adjusted gross income) to calculate how much you owe in taxes, the goal of tax planning is to reduce your lifetime AGI.
Reactive Tax Preparation
Traditional tax preparation is entirely reactive. Either you or a hired tax professional gathers all of your financial documents (hyperlink to blog on important tax forms and documents) from throughout the past year and uses basic filing strategies and deductions to lower your AGI for the current previous tax year.
This process severely limits the options you have available to you because all of your tax year events have already occurred.
Proactive Tax Planning
Tax planning, on the other hand, is proactive in nature and takes a comprehensive look at your finances.
You, your financial advisor, and/or your tax professional account for your financial picture and take a long-term, strategic approach to minimizing your tax liability for the upcoming year (and all the years thereafter). As mentioned above, the goal is to minimize the amount of your lifetime AGI.
Each year, you will preemptively know the tax implications of each of your financial decisions, allowing you to prepare for future tax years.
Asset Allocation and Retirement Accounts
Taxes affect almost every area of your financial landscape. Correct allocation of assets and effective use of retirement accounts are two of the most accessible methods to reducing your tax burden.
Asset Allocation
By owning municipal bonds, individual stocks and bonds, ETFs, and other tax-efficient assets, and taking advantage of strategies such as direct-indexing and tax-loss harvesting, you can improve your personal returns on your holdings by reducing your tax burden.
However, there is not much flexibility when it comes to tax-efficient asset allocation, and only the most experienced advisors will be able to offer solutions in this realm, unless you consider alternative assets.
Retirement Accounts
Retirement accounts are simpler and more powerful tools for lowering your AGI.
As a general rule of thumb, maximize every account the IRS has placed contribution limits on, whenever possible. This includes 401(k)s or 403(b)s, HSAs, 529s, IRAs, TSPs, and so on.
These are all highly tax-incentivized accounts for retirement, medical expenses, and college savings – take advantage of them. Your employer may also offer matching benefits for some of these accounts, matching your contributions dollar-for-dollar up to a certain limit. This is nearly free money and should be viewed as part of your salary and not ignored.
Talk to your HR department to find out more about your company’s benefits. Correctly utilizing each one of these accounts instead of individual brokerage accounts and basic savings accounts can be the difference in hundreds of thousands of dollars over a lifetime.
Estate Planning
If you have children or other heirs, estate planning is essential (and no, it’s not only for the wealthy!). Estate taxes can be a considerable and immediate burden on your heirs. Fortunately, there are a multitude of strategies to minimize that inevitable tax liability (and, consequently, maximize the amount you leave to your heirs).
Knowing how each of your different retirement accounts or other assets will be taxed upon your eventual demise will have a very real impact on how and from where you take distributions while you’re living.
Additionally, if you have a large estate (and/or high income), proactive tax planning can allow for annual charitable contributions to your favorite organizations, with money that would otherwise be going to the government.
Tax Planning by Age
Younger Individuals
Although tax planning is most often thought of in and around retirement age, there are a lot of benefits to beginning much earlier. In general, since your tax responsibilities revolve around your AGI, your peak earning years (your highest tax bracket years) will be when tax breaks can help you the most.
Large purchases, such as a wedding or a first home purchase, present opportunities for savings if the nuance of tax laws are properly understood. Because of the power of compound interest, every dollar saved in taxes while you’re young can multiply many times over by the time you reach retirement.
Additionally, a proactive tax plan will take a long-term approach to your tax savings. This will dictate how savings are allocated between tax-deferred, tax-preferred, and tax-free savings vehicles, potentially saving substantial amounts of tax that would be spent in future retirement.
Older Individuals
Social Security, RMDs (required minimum distributions), Roth conversions, real estate transactions, HSAs, charitable giving, healthcare premiums- Every decision you make regarding any one of these areas will affect your taxes. If you feel overwhelmed, you’re not alone. And that’s not even an exhaustive list!
The good news is: You don’t have to go at it alone. This is where financial advisors can help you with a long term plan. They not only pay for themselves with the money they save you, but also give you the assurance and peace of mind that your financial life is protected.
There are myriad strategies available to you as you approach each one of these decisions. A financial advisor can connect all the puzzle pieces and make sure you’re using each one of them to their greatest potential, maximizing every dollar you’ve spent a lifetime accumulating.
Summary
No financial situation is too simple or complex (or small or large) not to benefit from proactive tax planning – there is value to be added everywhere. Keep more of what’s yours with proactive tax planning.
By working with a qualified tax professional and proactive financial planner, you can be assured that you are taking advantage of every opportunity afforded to you and minimize your lifetime tax bill.
Certified Financial Planners™ at Advanced Retirement Strategies
Working with a Certified Financial Planner™ is an excellent investment of your time and money. With the high standards for CFP® certification, you’ll know you’re getting the expertise and knowledge of a highly-trained and educated professional who will always act in your best interests and with the loftiest ethical standards.
The team of retirement planners and investment advisors at Advanced Retirement Strategies in Bountiful, Utah includes two Certified Financial Planners™ who specialize in helping diligent savers with $250,000 or more of investment and retirement assets (not counting your primary residence) prepare for and then transition into retirement.
If you’re looking for a CFP® to help you live the retirement you have dreamed of, contact us today.
