Part 4: Tax Planning

Austin Colby, CFP^®, MBA

Tax planning is one of the most misunderstood areas of financial planning. From the complexity of how income taxes, Social Security taxes, and various investment taxes are calculated, to the fact that the tax code changes in some capacity almost every year, it’s no wonder that people are confused when it comes to this subject.

In the context of income tax planning, most people think the goal is simply figuring out how to lower income tax liability from the previous year. While it is true that we look for areas to improve year by year, it is even more important to us to determine tax planning opportunities that improve your tax situation over the next 20, 30, and 40 years.

When working with our client families, we have found that focusing only on the recent past can lead to missed opportunities for the future. Without a long-term, ongoing tax plan in place, big picture items get missed and it can be difficult to stay the course.

Within portfolio management, there are tax-planning considerations that play a big role over the life of your portfolio. For example, we use tax-efficient investment vehicles inside of non-retirement accounts. Because those accounts report any income and realized gains in the calendar year they occur, it is important to use investments that have little to no tax-cost drag on an annual basis.

Another portfolio-based tax strategy we employ is keeping more growth-oriented investments (stocks) inside of future tax-free accounts, like a Roth IRA. If we know the investment dollars will ultimately be withdrawn from the account with zero income tax liability, it means we want to keep the growth portion of the portfolio inside those accounts.

Another example of an important area of tax planning revolves around charitable gifting. There are many ways to give money to your church or charity of choice, but not all of them are the best for your plan. Depending on your unique situation, gifting appreciated securities directly from your portfolio could be the best method of giving. If you are age 72 or older, making charitable contributions directly from your IRA is another excellent tax-reduction strategy. In years where you know you will have a significant increase in income, establishing a Donor Advised Fund might be appropriate.

While often overlooked, good tax planning can lead to tens—even hundreds—of thousands of dollars of after-tax savings when implemented properly in your financial plan.