Back To Basics With Tax Planning
A truly comprehensive financial plan is the sum of many parts. While investments are an important component of any plan, tax planning can sometimes be overshadowed by investment planning, and it’s not hard to see why. Behind every potential stock investment is a company with a story, and people relate well to stories. Financial markets are also fast-paced and volatile, which can make them exciting. And let’s face it – the US tax code is a pretty dry subject for most people. But it’s hard to overstate the impact that minimizing lifetime taxes can have on a client’s ability to achieve their financial goals.
What are some insights?
With tax season here again, this month I’d like to share a few insights that I’ve learned from tax planning for clients:
- The federal income tax structure in the United States is highly progressive, meaning that marginal tax rates are very low for low levels of income, remain fairly low for moderate income amounts, but rise rapidly at higher income levels. High earners don’t just pay more in taxes, they pay at a much higher rate than lower earners. To illustrate, here are the federal tax rates in effect for 2024:
Source: Internal Revenue Service
Tax Rates At A Glance
Marginal tax rates range widely from 10% to 37%, but the vast majority of Americans are spared from the highest tax rates. For example, a married couple could earn up to $94,300 this year in taxable income and remain in the 12% federal tax bracket. When you consider that the standard deduction for married couples is $29,200 this year, this means that a couple filing jointly could actually earn up to $123,500 in gross income and pay no more than 12% in federal taxes. A good deal of tax planning involves simply being aware of these rates and targeting a certain level of taxable income each year.
2. In the United States, tax liability is generally a function of income, not wealth (property taxes being a notable exception to this rule). As a result, many wealthy people avoid paying a lot of tax by controlling or limiting their taxable income, thus appearing more like a “non-wealthy” person in the eyes of the IRS. Offsetting capital gains with losses, incurring real estate or business losses, investing in municipal bonds, and withdrawing from Roth accounts are just a few of the ways it may be possible to limit taxable income for some taxpayers.
3. Marginal tax brackets, income limits for contributions, and standard deduction amounts are adjusted for inflation and tend to change every year. Marginal tax rates, however, change much less frequently, and usually only after an act of Congress. Today’s marginal tax rates are quite low historically, although a big change may be coming in 2026 when many of the provisions of the Tax Cuts and Jobs Act expire on December 31, 2025. For the next two years, tax planning will include the need to take advantage of these lower rates while they still exist.
4. In general, there are many more opportunities for tax planning after retirement than before. This is because in the “accumulation” phase, most taxable income generally arises from salary and wages. But in the “decumulation” phase, when portfolio withdrawals begin, retirees generally have more control over the amount (and the kind) of income they recognize each year, and tax planning can take a more central role. This is especially true before Social Security benefits and Required Minimum Distributions begin.
5. There are dozens of different kinds of financial accounts available to savers and investors. Just trying to learn the acronyms (IRAs, 401(k)s, 403(b)s, SEPs, Simples, Roths, HSAs, JTWROSs, …) can be overwhelming. But nearly all financial accounts tend to fall into just three broad categories, which are based on their particular tax treatment under the law. In general, you either pay taxes on contributions before the money goes in, on withdrawals after it comes out, or at the end of each year based on the amount of investment income or net capital gains each year. I’m simplifying things here, but that’s pretty much it.
6. Tax planning is a long-term affair – it is much more than simply trying to minimize your tax bill each year. Rather, the goal should be minimizing lifetime taxes. This means that sometimes, it can be advantageous to purposely pay a little more in taxes now in order to save a lot of taxes in the future.
While this article describes some of the basics of tax planning, it is by no means a comprehensive review of the subject. Please note that every individual’s financial situation is unique, and many of the strategies discussed here may not be relevant to you. As always, we encourage you to seek professional guidance before pursuing any particular tax strategy yourself.
Speak with a qualified Elevate-Wealth professional today about financial planning!
Sources : www.irs.gov
