Financial planning is a huge part of what we do here at Creekmur Wealth Advisors, so it's no surprise that tax planning is one area we spend a lot of time working in. When I talk about tax planning I am not talking about filling out and submitting your tax return every April 15th. Filing your taxes is necessary, but it's reactive or backward-looking. Tax planning, on the other hand, is a forward-looking, comprehensive approach to reducing lifetime taxes and increasing overall after-tax wealth.
We all know that tax laws in our country can change over time. For instance, in 2017 the Tax Cut and Jobs Act was signed into law which made sweeping changes to the existing tax code. Among many others, there is one that affects nearly every one of our clients - a change in tax brackets and rates.
With the passage of that Act, nearly every bracket saw a reduction in tax rate as well as an increase in the size of the brackets themselves. With the new (possibly temporary) tax brackets in place, an opportunity has been created for individuals and families to move IRA dollars from pre-tax status to tax-free status by paying taxes at the current lower rates. When you factor in tax-free growth along with the ability to avoid Required Minimum Distributions, the total value of such a strategy could number in the millions. And while not every client will experience millions of dollars of benefits from such a strategy, tax planning still has the potential to move a financial plan from good to great if done correctly. For more on this read our blog post on “back door Roth contributions”.
I know what you may be thinking…”I’m just starting out in my financial journey, how much can tax planning really benefit me at this stage?” The answer is—quite a bit.
By making wise decisions in your current situation, you can set yourself up for success in a way that makes future planning more effective because you will not need to undo or fix portions of the plan that were not initially coordinated. For instance, you may be faced with the decision of contributing to a Pre-tax 401k or a Roth 401k. The easy answer would be to go with the Roth because of the tax-free growth. Keep in mind, that by choosing the Roth option you would be increasing your taxable income which could potentially affect your ability to qualify for other tax benefits—for instance, a premium tax credit for health insurance plans.
As part of our Five Minute Finances series Drew Creekmur, MSPFP recorded a video answering many questions regarding Traditional & Roth IRA's.
Proper tax planning prior to retirement can vastly improve the success of your plan as you live it out during retirement. Did you know that as much as 85% of a retiree’s Social Security benefits may be taxable in retirement depending on how you structure your income during retirement?
In 2021, the largest monthly benefit a retiree can receive at age 70 is $3,895. If you were in the 22% tax bracket and had to pay taxes on 85% of those benefits, you would owe $174,807.60 in total taxes through age 90. That’s $174,807.60 that you were unable to spend over the course of your retirement or $174,807.60 that you were unable to pass on to heirs after your death. Proper tax planning has the potential to reduce or even eliminate the amount of your retirement income and assets that you send off for taxes.
As with everything we do, we feel it is best to look at the entire financial picture before coordinating a strategy that best achieves your goals. Retirement planning is part of that, investment planning is part of that, and tax planning should also be part of that.
Andy Anderson, CFP®