Tax Planning for Beginners

Posted by Connor Creekmur, MBA on 1:14 PM on April 5, 2022
Connor Creekmur, MBA
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“Nothing is certain but death and taxes” -Benjamin Franklin.

The more time I spend in the financial services industry, the more I see this quote proving to be very true. 


There are not many certainties in life, but the things we do know for certain, we like to plan for and taxes are one of those certainties. You may have already filed your taxes, but planning for taxes is different matter.  Since it's tax season, there is no better time to review your financial plan to ensure your financial life is operating as efficiently as possible!

The Basics – Understanding the Tax System in the US

In the United States, you are taxed as a percentage of the income you make through a progressive tax system. As your income increases the percentage paid in taxes also increases. By considering your current income level and what your future earnings may be you can develop an efficient tax plan when it comes to your retirement savings.

In this blog, we are going to discuss two different kinds of accounts: a traditional tax-qualified account and a Roth account. Both options have great tax benefits. Both allow funds to be invested and grow tax-free or tax-deferred. You can make trades in your account and will not need to pay taxes on the gains.

Unfortunately, taxes are a certainty, and the way these accounts differ, and how they may fit into your unique financial situation, is in the way they are taxed.

Traditional Pre-Tax Accounts (401(k), 403(b), 457, IRA, TSP)

A traditional pre-tax account is an account that allows you to deduct contributions from your taxes. So, you are effectively not paying taxes on whatever you put into the account. The funds are taxed when they are taken out, or distributed, from the account. If you are under the age of 50 you can contribute $6,000 per year to an IRA and if you are over the age of 50 you can contribute up to $7,000 per year to an IRA.

One key long-term tax planning component to keep in mind is that traditional pre-tax accounts have required minimum distributions (RMDs). These are payments that must be taken out from your pre-tax accounts when you reach age 72 so they can be taxed by the IRS. The rules around RMD age requirements, distributions, and timing are constantly changing. Getting this aspect right with your financial plan is critical for those approaching RMD age.

Tax Planning Tip: A traditional pre-tax account is beneficial to fund if you are in a high tax bracket and you believe your income at retirement will be lower. You will have tax savings when you are earning more and will pay taxes at a potentially lower rate when distributed.

The major drawback is that you may not need to draw from your traditional account for income, but you will be required to take a taxable RMD. This is when a Roth Conversion may be beneficial. If you have questions if a Roth conversion is appropriate for you, please reach out to a financial advisor or check out this blog for more information.

Roth Accounts (Roth 401(k), 403(b), IRA)

A Roth account is funded with money that has already been taxed. The account grows tax free just like the Traditional account. However, it will not get taxed when you make a qualified distribution. To be considered "qualified" the account must be open for 5 years and the account owner must be over 59.5 years of age. Similar to the IRA, if you are under the age of 50 you can contribute $6,000 per year to an IRA and if you are over the age of 50 you can contribute up to $7,000 per year to an IRA.

Tax Planning Tip: This account tends to be most beneficial for earners in lower tax brackets who believe they will be in a higher tax bracket in the future. This is because they will be able to withdraw the funds tax-free in retirement and use the funds as tax-free income effectively avoiding higher tax rates.

Additionally, Roth accounts do not have RMD's, so it will not impact your income level in retirement and potentially push you into a higher tax bracket. Read here for more on this topic.

Tax Diversity

As with all investing diversifying is important.

Tax Planning Tip: If you have a traditional account in your workplace plan, a Roth IRA may be beneficial and vice versa. Having tax diversity can give you options in retirement.

If you have questions about the most tax-efficient investment strategy for you, I would recommend reaching out to a financial advisor for a more in-depth strategy session. Talking with a financial professional is a great way to develop your investing strategy early on.  

Connor Creekmur, MBA

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Topics: Financial Planning, IRA, Roth IRA, tax deferred growth, Tax Planning

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