Broker Check
Tax Planning, A Key Ingredient For Your Financial Planning Recipe

Tax Planning, A Key Ingredient For Your Financial Planning Recipe

March 14, 2023

Taking a proactive approach to tax planning can offer added flexibility and better outcomes leading up to retirement and beyond.

Tax planning is an essential part of any financial plan. Whether you are at the height of your career, a retiree, or someone who is preparing to retire, taking a proactive approach to tax and income planning can help you optimize your portfolio and create flexibility in retirement. In this blog post, we will cover the basics of tax planning and discuss some strategies for managing taxes, such as qualified charitable donations, Roth conversions, tax loss harvesting, and more. 

Let's start by understanding tax brackets. Tax brackets are rules that decide how much money people have to pay in taxes. Knowing which tax bracket you're in helps you manage your finances and save money. When you understand how tax brackets work and plan accordingly, you can pay the lowest amount of taxes possible.

Your tax bracket is determined by the amount of your taxable income after deductions and exemptions are subtracted. Tax brackets are broken up into different filing statuses; single, married filing jointly, head of household, etc. Knowing your tax bracket is key when it comes to reducing taxes, as you want to ensure that each dollar you earn is taxed at the lowest possible rate.

One way to reduce your taxable income and lower your tax burden is to take advantage of credits and deductions. Credits reduce the amount of taxes you owe on a dollar-for-dollar basis. Deductions are subtracted from your taxable income, which can translate into savings at tax time.

Depending on your filing status and other factors, there may be certain credits or deductions that you're eligible for, such as student loan interest deductions, earned income credits, child tax credits, and more. If you own a business or are self-employed, there are other deductions available such as the home office deduction, vehicle expenses, healthcare costs, and more, that can further reduce your taxable income.

When it comes to tax planning, being proactive is key. Tax management involves using strategies to reduce or eliminate taxes on your investments. Here are a few common strategies used by investors: 

  • Donor-advised funds (DAFs) are a great option for those looking to make charitable donations while also receiving tax advantages. DAFs are set up through a public charity and allow the donor to make an irrevocable contribution of cash or other assets to a fund. DAFs provide donors with numerous potential benefits, including immediate tax deductions, capital gains avoidance, and estate planning options.
  • Qualified Charitable Donations (QCDs) - Charitable donations are a great way to reduce your taxable income while also supporting causes that matter to you. By donating money directly from an IRA or other retirement account, you can avoid the additional tax burden of having to pay taxes on those funds first before donating them. This is known as an "above the line" deduction. The catch - you must be 70.5 years or older.
  • Roth Conversions - Roth conversions allow you to convert (pay income tax now) traditional IRA or 401(k) funds into a Roth IRA account. This conversion allows the funds in the new account to grow tax-free for as long as they remain in the account. It also eliminates any future required minimum distributions (RMDs) from the original account since all of the money has been converted over. This can be a great proactive planning strategy for early retirees, those looking to leave tax-favored inheritances to their heirs, or those who will not need the full amount of their Required Minimum Distributions in later years.
  • Tax Loss Harvesting - We've all heard the old adage, "when life gives you lemons, make lemonade." This strategy is no exception. Tax loss harvesting can be an effective strategy for reducing taxable income by selling investments that have lost value and replacing them with similar investments in order to generate capital losses, which can be used to offset taxable gains from other investments or activities.  This strategy should be used with caution, though, since there may be limitations on when to leverage it and when not to. Similarly, there may be instances where harvesting gains may be beneficial, especially for folks who have a substantial carryforward loss to raise their cost basis. 
  • Medicare and Social Security Coordination - Both Medicare and Social Security benefits are subject to taxation if certain criteria are met, including income limitations and filing status requirements. If you find yourself in one of these situations, it may be beneficial to consult with a financial advisor or tax professional who can help develop a plan that minimizes these taxes while still maximizing the benefits received from these programs.
  • The SECURE Act 2.0 – The SECURE Act 2.0 (Setting Every Community Up for Retirement Enhancement) was passed by Congress at the beginning of the year and provides several changes that could affect investors, including changes to Required Beginning Dates, catch-up contributions, Roth provisions inside qualified retirement plans, conversion opportunities for unused 529s to Roth IRAs, and more!  It’s important to understand how these changes might impact your current financial situation so that you can take advantage of any potential benefits available under this new legislation

We believe tax planning is an essential ingredient of any comprehensive financial planning recipe. While the tax code is intended to be black and white, coordinating and combining various strategies can be a work of art. 

Key Word - Timing

Consult With Your Financial Or Tax Professional To Better Understand How To Best Manage Your Tax Situation