There is an old adage that says, ‘it’s not what you make that matters, it’s what you keep that can make a difference.’  When it comes to creating and managing wealth, the greater we can control and limit taxes during your lifetime, the greater resources you’ll have for your family and be able to positively impact the people and causes that matter to you.

Tax planning isn’t a one-time process.  To truly build and leverage your assets, tax planning is something that must be maximized throughout your lifetime with a sound tax planning strategy.  How do we do this?  There are countless steps we can take at different stages of life.

Pre-Retirement

For those who are actively working, there are several tax planning ideas to consider.  The first three listed below are essentially an asset shift strategy, whereby you are shifting assets you would otherwise have in taxable account (bank or brokerage) into a retirement account.

• Pre-tax Savings:  Saving money in a pre-tax company sponsored retirement plan is the first and easiest strategy to employ to reduce your tax bill.  If you save $1 in a pre-tax company retirement plan such as a 401k or 403b, you’re saving between 20-45 cents of that dollar the government (federal & state) would have taken (depending on your current tax bracket), if you didn’t participate in the savings plan.  Eventually, you’ll need to begin withdrawing these assets in retirement and will pay tax on 100% of the withdrawals.  If your tax bracket is lower in retirement than it is today, as is frequently the case, you’re saving taxes.  Of course, no one knows what tax rates will be in the future when you’re ready to begin withdrawals, but people often have a lower tax rate in retirement.
• Traditional IRAs:  If you have assets sitting in a bank or brokerage account, those assets typically generate income and capital gains, all of which you are taxed on.   By contributing to an IRA, you’re able to defer gains into the future and possibly withdraw them when you’re in a lower tax bracket.  This strategy is particularly effective if you have investments that generate income, which is taxed at a higher rate than investments that generate capital gains.
• Roth IRAs:  Expanding on the concept above for traditional IRA contributions, if you’re eligible for a Roth IRA, you’re able to contribute after tax income to an account that will never be taxed again. Contributing to Roth IRAs also allow you to control your tax bracket in retirement, which we will explore shortly.

Note:  Assets held in retirement accounts are protected from litigation and bankruptcy.  In addition to the potential tax benefits, these accounts provide a distinct asset protection feature.

• Home Ownership:  The current tax code (1/2017) allows for the deduction of property taxes and mortgage interest.  Owning a home, relative to renting, provides the advantage of deducting your property taxes.  In addition, home mortgage interest is also a deduction.  For those who own homes that are fully paid for, there is a tax incentive to carrying a mortgage.  If your mortgage rate is 4% and you’re in the 30% tax bracket, your true cost of money after deducting the mortgage interest, will be closer to 3%.  If you believe you can invest the money and earn a higher return than 3%, you’re both saving taxes and growing your investments, which is a two-fold wealth creating strategy.
• Bunching Tax Deductions:  If your annual tax deductions are close to the standard deduction, it may make sense to bunch 2 years of tax deductions, such as property tax, into one year.  This would allow you to itemize a large deduction in one year and utilize the standard deduction in the following year.
• HSAs:  Contributions to Health Savings Accounts (HSAs) are tax deductible. Funds in a HSA grow tax deferred, and qualified withdrawals for heathcare expenses are tax free.  This is one of the rare triple tax savings vehicles available.  Maximizing contributions to HSAs and paying ongoing health expenses out of pocket during your working years can make sense, building a tax free health care bucket to pay for health expenses in retirement.

Nearing Retirement

• Maximizing Retirement Plans:  For people over the age of 50, there are ‘catch up’ contributions allowed by employer sponsored plans, IRAs, and HSAs.  It’s not uncommon to have scenarios where reaching the upper savings limits for these plans has constraints on your current cash flow, especially for dual income spouses.  Assuming you have sufficient savings in bank or brokerage accounts, it’s to your advantage to maximize your contributions to your retirement accounts to draw down your taxable income and utilize bank or brokerage assets to supplement your cash flow.
• Planning Charitable Contributions:   This strategy can be used anytime, but is frequently used in the last year or two of full employment, when your income is especially high.  During high tax years, you can make a larger than normal charitable contribution to a Donor Advised Fund (DAF).  In addition to getting a larger charitable deduction, the charitable deduction is worth more in years you have high tax liability so we want to maximize this benefit.  Frequently people will pre-fund 5 or more years of charitable contributions into the DAF to maximize this deduction.  Once the funds are in the DAF you can make donations to your preferred charities over time.
• Long Term Care Deduction: If you have purchased long term care insurance, many states such as Wisconsin allow a portion of your premium payments to be deducted.  Check your state income tax code.
• Paying Long Term Care Premiums:  If you have a long term care insurance policy AND you have non-qualified deferred annuities, you are able to pay the LTC premium from the annuity with pre-tax dollars.  In other words, withdrawals sent directly from an annuity to pay for an LTC premium aren’t taxed.

Retirement

• Income Planning:  At retirement your wages drop and you’ll pay taxes on investment, pension, and social security income as well as withdrawals from retirement accounts and annuities.  Planning the timing of your income flows in the context of your overall financial plan, can provide a huge tax savings.  If you are married and your spouse also has assets and income sources, it’s imperative to coordinate all scenarios.
• Tax Bracket Maximization:  Expanding on the income planning idea above, large tax savings can occur over time when individuals maximize their current tax brackets.  As an example, someone may be in the middle of a given tax bracket but have the potential to accelerate additional income via an IRA withdrawal or Roth Conversion, bringing them towards the top end of their respective bracket.  This is done in instances where a larger future tax liability is predicted.  This happens most often when someone has large Required Minimum Distributions (RMDs) that must be taken from qualified retirement accounts.  A beneficial technique to smooth tax liability over time is to facilitate partial Roth IRA conversions to maximize tax brackets from retirement age until age 70.  If you’re retired, but under age 70, this technique should be explored.

Advanced Techniques

• Charitable Gifting:   Gifts to qualified charities serve as a tax deduction.  The more money you give to charity, with certain constraints, the less you pay in income taxes.  If you have appreciated assets, such as stocks, mutual funds or even real estate, it makes sense to give shares of these investments directly to the charity.  This strategy provides a charitable tax deduction and helps you minimize future capital gains taxes.  If you’re writing checks directly to charity, you’re missing out on a tax saving opportunity.
• Family Planning:  It’s not uncommon for high net-worth families to recognize they will never outlive their money.  At that point, the objective is to maximize the tax code looking at the entire family’s situation.  Family members in the lower income tax brackets pay less, and sometimes no capital gains tax.  Shifting assets to lower income children can create large tax savings for the family.

If you are not eligible to contribute directly to a Roth IRA where assets are allowed to grow tax free, it’s possible to gift assets to your children so they can contribute to their Roth IRAs, assuming they qualify.

• College Savings Plans:  529 plans are designed to help individuals pay for college.  Assets in 529 accounts grow tax free and are withdrawn tax free if they are used for higher education expenses.  In addition, many states allow tax deductions for contributions to specific 529 plans, so additional tax savings can occur.   In those states, not only can you receive a tax deduction for contributions made on behalf of your child, but you can also set up an account in your name and receive the same tax deduction.  As college expense come due, you can simply shift assets out of your 529 account to the child’s before paying the bill.

Business Owners

There are an array of tools and techniques available to business owners to maximize the tax code and minimize their tax liability.  Please contact us to learn more.