Tax Planning

Many people overlook the importance of tax planning when it comes to their investments and retirement planning.  Some investments are inefficient to own in a taxable account and are better owned in IRAs or other tax deferred accounts.  Making smart tax decisions can have an enormous impact on the total wealth you accumulate in your lifetime.  With the reintroduction of the 39.6% tax bracket and the new 3.8% Medicare surtax on investments, the IRS can be up to a 43% partner in the profits of your investment income.

I help people keep more of their hard earned money.  One of the ways I do this is by helping clients understand that there are three major buckets that you can save into for retirement.

Taxable Bucket

The first bucket is the taxable bucket.  The taxable bucket is typically a brokerage account that allows you to own stocks, bonds, and mutual funds.  You invest after-tax money into the account and receive a 1099 DIV and 1099 INT each year on the dividends and interest.  When you go to sell the investment, you pay a short term capital gains tax (tax rate is your ordinary income tax bracket) if you have held the investment for less than a year and long term capital gains rates (0-20%) if you held it for over a year.  The advantages to this bucket are long term capital gains rates are lower than your ordinary tax bracket and you can get to your money at anytime.  Many people are not aware that if a married couple has a taxable income of less than $73,800 (for tax year 2014) they don’t have to pay any long term capital gains tax.

Pre-tax Bucket

The second bucket is the pre-tax bucket.  Investors are typically using 401(k)s, 403(b)s, and deductible IRAs to fund this bucket.  This bucket rewards you with a tax break for contributions.  If you make $100,000 and invest $5,000 into a deductible IRA, you will only be taxed on $95,000.  The second advantage to pre-tax investments is that they grow tax deferred.  You don’t get 1099s like the taxable bucket each year and you don’t have to keep track of your tax basis or worry about capital gains when you dispose of investments.  The disadvantage to the pre-tax bucket is that distributions are added to your gross income and are fully taxed.  You also have to pay a 10% penalty in most cases if you are not 59 and 1/2 or older when you make the withdrawal.

Tax Free Bucket

The last bucket is the tax-free bucket.  It is the exact opposite of the pre-tax bucket.  Here you invest with after-tax money, it grows tax deferred, and when you make withdrawals, it comes out tax free.  Roth IRAs, Roth 401(k)s, and cash value life insurance are common vehicles for this bucket.  This bucket doesn’t help you at all when you make the contributions, but it is the best place to have money when you are retired.

Not even our current Congress knows what tax rules will be in place when you retire.  It is important to consider the above and design a plan that is specific to your situation that incorporates tax diversification so that you have more choices when it comes time to begin the distribution phase of your investment life.

There are a number of other strategies that I can share with you to reduce your overall tax burden based on your situation.  Click here to schedule a complimentary consultation.