How did April 15 go for you? Was your tax bill in the ballpark or was it a big surprise? Most financial decisions have tax impacts. You can ignore them or plan ahead, but we highly suggest tax planning for 2019 and beyond. Tax planning is about arranging your affairs to postpone or minimize taxes. Benefits include higher probability of achieving your goals and planning your cash flow with greater certainty. Live your life as you choose but do it in a tax-smart way.
Here are some tax-planning topics to discuss with your financial advisor and tax professional:
Coordinated planning and total wealth framework
Tax planning is a part of your personal financial planning. They are done together, not separately. Also, tax planning should incorporate your total wealth — your earnings, Social Security, pension (human capital) and your personal, business and retirement assets (investment capital).
A means to the end
Tax minimization is a worthy goal. However, there are other considerations in making life choices besides tax avoidance. I’ve seen this case many times: “This property is becoming a burden, but we can’t sell it now … the kids inherit a stepped-up basis after we die,” or “I can’t sell this heirloom stock… the gains will kill me.” Don’t let the tax tail wag the dog.
Complexity and uncertainty are common in long-term planning. Nevertheless, wise mentors coached me to generally plan under current legislation and adjust as tax reform occurs. Here’s an example — some mature investors want to convert their retirement accounts to Roth IRAs. They feel taxes are high or will continue to increase for the next three to five decades for them and their kids. That’s a long time for future Congressional tax reforms. Maybe Congress will eliminate inherited Roth’s except for surviving spouses. Do you prefer to pay income taxes for your kids or have them pick up the bill?
Life stages and tax effects
There are generally four major life stages for adults — three adult stages (young, middle and older) and retirement — and each has unique tax issues.
· Income sources generally shift from wages to investment income over time (plus Social Security and pension in retirement). Income is taxed differently – non-taxable, capital gains (zero, 10 or 20%), dividends (ordinary income or capital gains), ordinary income (max of 37%), and the 3.8% so-called Medicare Surcharge Tax. What’s the best way to shift to the lowest brackets?
· Your asset base starts at ground zero, then grows and accumulates, and begins to deplete in retirement and investment strategies shift. Invest tax efficiently!
· Adjusted gross income tends to start low, then higher and highest, and then lower.
· Deductions often parallel with your adjusted gross income’s (AGI) path. Deductions are most valuable when AGI is highest. Do you maximize retirement contributions, payoff the mortgage or both?
Tax advantages support certain financial goals
Home ownership provides deductible property taxes and mortgage interest (with limits). Retirement savings is encouraged with tax-deductible contributions (limits) and tax deferral. And there are advantages for education and healthcare savings (e.g. 529 plans and Health Savings Accounts), as well as charitable giving strategies.
Inheritance or gifts generally do not create immediate tax consequences to beneficiaries, but investment income and capital gains do. Personal injury settlements can be non-taxable (physical damages) and taxable (punitive damages) depending on the case. Casualty and theft losses, or medical expenses can have tax consequences.
Numerous planning opportunities include employee benefits (healthcare and retirement savings), compensation design, structuring capital investments and succession planning.
Tax efficiency is important in financial planning. At the end of the day you get to spend, gift or reinvest what remains after Uncle Sam takes his share.
Secure your future wisely.
Brian Loy, CFA, CFP, is president of Reno-based Sage Financial Advisors Inc. Contact him at www.sagefinancialadvisors.com or firstname.lastname@example.org.