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You've worked hard for your money.
That's why it can be so disappointing to see much of your earnings paid out to Uncle Sam.
Paying too much in taxes can make you feel like your running on a treadmill, never actually moving forward as hard as you try.
The problem is that many investors and even financial advisors don’t take retirement tax planning seriously. After all, it takes time and specialized skills to fully integrate your retirement tax plan with your life plan. These two requirements are often big enough barriers to avoid taking the necessary steps.
Depending upon your situation, the little known secret is that retirement tax planning has the potential to save you hundreds of thousands of dollars over time.
That's why retirement tax planning is integral to your total financial plan and something you should keep current. A proactive retirement tax plan can set you up for success today and tomorrow.
I can speak from experience.
After having advised hundreds of families over the past seventeen years on retirement tax strategies and investing in retirement, I’ve learned that retirement tax planning may strengthen your financial security, help you maintain your lifestyle in retirement, and help you keep more money in your pocket.
Ultimately, there are many reasons that you or your financial advisor should do tax planning. It’s worth it for those who are willing to invest a little extra time getting started.
You’ve worked hard for your retirement savings, and you deserve to pay no more in taxes than you are legally required.
To help you on your journey through your next chapter in life, here are seven critical benefits of retirement tax planning based on real-world experience.
Oh, and don't forget your free cheat sheet to help you quickly put it all in context.
1. Retirement Tax Planning May Keep More Money In Your Pocket
Of course, no one likes paying taxes, but it is inevitable as long as we have public roads, education, and national defense. We all do our part to pay for it, but just because you value things that taxes provide doesn’t mean you have to be careless about what you pay.
What if you're overpaying? The truth is that you may not know until you get help.
Vanguard estimates that investors may add an additional 0.60% per year in after-tax returns by implementing a single tax strategy called asset location. That’s $6,000 more per year in returns on a $1 million portfolio for one strategy.
As another example, the state of Virginia has a program whereby taxpayers can purchase tax credits at a discounted rate of between 8-12%. The result is the potential for saving $800 to $1,200 in taxes on every $10,000 in credits purchased per year.
That’s money that could be spent on date night with your spouse or an extra round of golf.
I remember working with a new client several years ago. They were charitably inclined and had given $15,000 a year to different charities over the past ten years or more. They were confident that they had been giving in the most tax-efficient manner.
After a quick review of their tax return, we discovered that their tax preparer had not properly implemented the strategy they thought they were following.
As a result, I estimate that this mistake cost them between $3,000 to $4,000 per year in additional taxes over a ten-year period.
That’s potentially $30,000 to $40,000 in tax overpayments to the IRS that could have gone right back into the client’s wallet, paid for a great vacation, or provided additional funds to give more to charity.
The good news is that you don’t need to be an expert in retirement tax planning.
A Certified Financial Planner who focuses on tax planning should be able to help you create a tax plan that ensures you retain as much of your hard-earned money as you legally can.
There are many strategies available to help you, including:
Tax-loss harvesting—strategically selling assets at a loss to offset more significant gains.
Tax-gain harvesting—strategically realizing gains at lower tax rates to create smaller gains in the future.
Asset location—housing securities in the most tax-efficient accounts. This can help determine the proper asset allocation for your risk tolerance, time horizon, and goals.
Balancing tax buckets, like taxable, tax-deferred, and after-tax accounts.
Charitable giving—optimizing your giving efforts to maximize your donation and save money on your tax bill.
State tax credits - Virginia and other states provide land preservation tax credits that may be purchased, thus reducing your overall tax liability.
Reducing your taxes spills over into other areas of your finances. When you proactively manage your adjusted gross income (AGI), you may have more control over taxes in other areas such as Social Security benefits, Medicare premiums, net investment income tax, and more.
There are a lot of pieces, and you can gain the most value by thinking about them comprehensively. Don’t employ individual tactics without considering how they fit into the big picture!
2. Retirement Tax Planning Could Make Your Money Last Longer
A retiree's most palpable fear is running out of money.
That’s understandable, considering the effect that could have on your lifestyle. Tax planning may help your nest egg last longer by allowing you to keep more of it.
One of the best ways to accomplish this goal is with a custom withdrawal strategy.
If you are deliberate about when you will withdraw, from which accounts you will withdraw, and how much, you can navigate your taxes most efficiently. That sometimes means intentionally taking a taxable distribution or doing a Roth conversion even if it causes your taxes to go up one year.
Michael Kitces reports that implementing partial tax conversions has the potential to increase your net after-tax wealth.
Why?
Because a strategy like a Roth conversion can potentially lower your average taxable income long-term and maximize the number of assets you transition to your heirs.
The traditional rule of thumb is to take money from your taxable accounts first, then tax-deferred, then tax-free accounts like a Roth IRA.
Here’s the dirty little secret when it comes to the order of account withdrawals in retirement.
Traditional rules of thumb don’t always work best. Tax planning can help provide the personalized insights necessary, so you don’t pay more in taxes when creating the cash flow you need.
Retirement Reminder: Don’t neglect your planning window during your pre-RMD (required minimum distributions) years from age 60 to age 72! This is often a time when your income is lower, so you may consider building up your after-tax bucket with Roth conversions while you are subject to a lower tax rate.
Prioritizing Roth accounts will also give you more planning flexibility later by reducing your RMDs from your tax-advantaged retirement accounts.
But, Roth conversions aren’t right for everyone, and your personal tax situation will help dictate if they are right for you.
3. Retirement Tax Planning May Help You Reduce Capital Gains Taxes
Building a portfolio of low-cost investments can help save you money over the long term and may allow your investments to compound at a faster rate.
That’s good, but if you hold your investments in taxable accounts, those gains are taxable when you sell.
But if you consider your investments as part of a comprehensive tax plan, and coordinate it with your charitable giving to be tax-efficient, it may save you money.
Instead of realizing a massive gain and paying the tax bill, what if instead you donated investments to charity? If you donate appreciated assets directly, rather than selling them first, you may avoid the taxable gain entirely.
What if you don’t want to give to charity? When markets or individual investment positions are down, tax-loss harvesting can help preserve current losses on paper, allowing you to offset future gains.
You have to do it correctly, and this will likely involve a multi-year strategic giving plan to ensure you take full advantage of the available itemized deduction—and we can help!
4. Retirement Tax Planning Can Better Position You for Future Tax Law Changes
Benjamin Franklin once said there is nothing certain in life except death and taxes. I would like to add another to that list, which is changes to the tax code.
Politicians make a name for themselves through legislation. Legislation often includes changes to our tax code and tax rates.
As you can see in the chart below, individual income rates have changed numerous times since the early 1900s.
If you aren’t prepared, those tax law changes can cost you money and weaken your financial position. In my experience, most people wait to plan until it’s too late. Procrastination isn't planning, it’s reacting. Reacting puts you on the defensive and in a weak position when it comes to reducing taxes.
The truth is that nobody knows what tax rates will be in the future.
But, tax planning in retirement can help you develop a long-term road map in an effort to diversify your taxable income. When tax laws change, you may be in a better position to react.
5. A Proactive Retirement Tax Plan Enables You To Pass More Money To Your Heirs
Retirement tax planning can also spill over into your estate plan. By growing your accounts with taxes in mind, you may have more to pass on to beneficiaries and contribute to family generational wealth.
For example, would your heirs rather inherit $1 million in a Roth IRA or $1 million in a Traditional IRA?
A Roth IRA, of course!
That’s because every dollar withdrawn from a Roth IRA is tax-free, whereas every dollar withdrawn from a Traditional IRA (under normal circumstances) is fully taxable at the federal and state level.
That may mean transferring assets strategically and not simply building up a large estate may help maximize generational wealth.
Lastly, it could also make sense to give some money away while you're alive, so you don't exceed the federal estate exemption of $12.06 million (double for married couples) in 2022.
6. You Can Increase The Value of Charitable Donations
You don’t donate for the tax benefit, but for the good it does. However, when you think about charitable giving from a tax perspective, you'll actually be able to boost the overall value of your gift.
As noted before, donating an appreciated asset would be more valuable than donating cash you already paid taxes on.
Other excellent strategies to consider include qualified charitable distributions or QCDs, donor-advised funds, tax deduction bunching, and more. Which methods you employ depend on your tax bracket, savings, values, and goals.
7. Retirement Tax Planning Helps You Gain Peace of Mind
Life is full of stress. From worrying about your health to family members to your career, there is enough to worry about without also having to worry about the taxes you pay.
Proactive tax planning isn’t a one-time thing or something you put into a silo to think about on its own. Retirement tax planning is a long-term, comprehensive, multi-year process.
Creating that plan is worth every bit of the effort it requires, especially if you have professional help to take the brunt of the load off of you. It can help you feel confident and prepared for the future while also providing the peace of mind you need to enjoy life.
The less you pay in taxes, the more you have at your disposal. Saving all this money on taxes presents an excellent opportunity to reinvest those savings toward your long-term goals.
Paying fewer taxes could allow you to put more away for retirement, maximize Roth accounts, convert tax-deferred balances, or save for your health in an HSA. The point is that it’s your money, and you have options. Paying unnecessary taxes should be the last thing on your priority list!
Find A Financial Advisor To Help
At Covenant Wealth Advisors, we specialize in retirement tax planning, investing in retirement, and retirement income planning and have the experience, resources, and capacity to help you. We also encourage you to collaborate with your tax professional to ensure you implement the proper strategies on your annual tax return.
If you’d like to learn more about how you could benefit from a well-thought-out retirement and tax plan, watch our video on how we help and give us a call.
Scott Hurt, CFP®, CPA
Scott is a fee-only financial advisor and fiduciary at Covenant Wealth Advisors serving clients across the United States.
He specializes in retirement tax planning and helping individuals aged 50 plus create, implement, and protect a personalized financial plan for retirement.
Disclosures:
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital.
The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place.