It’s Tax Day!  Welcome back to the surface, all my CPA friends. Well done on this year’s efforts.  Get all the extensions filed and head out on your well-earned spring vacations! When you come back, let’s do coffee.

As for the rest of us, we tend to think of taxes as a necessary evil, which of course, they are.  It’s hard to love tax information. Now, before I lay some on you (tax love, that is) in honor of this auspicious annual event, I’d like to address something truly important in grammatical constructs.  And while my reach is not far (yet), I will be gratified if just one person learns this and uses it properly going forward:

If you want to reduce the tax you pay, you want to pay “less tax.”

and

If you want to reduce the different taxes you pay in your aggregate tax obligation, you want to pay “fewer taxes.”

Do not (and I will brook no argument) tell me that you pay “less taxes.”  I will hear of no such thing.  It’s my way or the highway.

Thanks for coming to my TED talk.

Your CPA is responsible for the taxes that matter this year. And most people are satisfied with an accountant who can minimize their taxes. But what about taxes in 10 years … or 20 years … or 30?  Who minimizes those?  That’s where you need to think ahead. And that’s the work of your financial planning team.

I’m going to share two ideas with you: 

·       Tax diversification for retirement income planning

·       Asset location to get the most growth with the least tax penalty from your portfolio.

As a rule, Americans have their wealth in two places: their home equity and their traditional retirement accounts. Both of these may benefit from adjustment prior to retirement; the first to render some of the equity liquid, and the second because traditional retirement accounts are taxed as income. For now, let’s put aside the first.

In a previous blog, I wrote that you are unlikely to be in a lower tax bracket in retirement. (See my post here.) Fact is, you’re likely to be in the same tax bracket in retirement as you were pre-retirement. As a result, everything that you distribute from your traditional retirement account will be taxable as income. And that’s on top of the 85% of your Social Security benefit that’s also being taxed. Got a pension? Taxable. All the later Boomers who have done what they were told by saving into their traditional retirement vehicles are going to share their retirements with Uncle Sam.  And it isn’t pretty.

Imagine growing your portfolio to $1 million or $2 million only to discover that you owe Uncle Sam $250,000 to $500,000 of that. 

If you’re in your 50s and you’ve done a good job of maxing your retirement accounts so you’ll have substantial taxable income in retirement, it may be time to look at traditional non-qualified accounts, saving on a Roth basis, or doing some Roth conversions. There are pros and cons to this, of course, because you’ll be paying taxes early; however, you’ll pay on a smaller amount, so there’s that.

The beauty of having three different tax treatments in your portfolio (income, capital-gains, tax-free) in addition to your home equity, is that you will be able to choose how much income you’ll show every year in retirement. You can decide how much comes from accounts that are taxable as income, taxable as capital gains, and non-taxable. 

Some clients love to finesse their income low enough to be in the zero-percent capital gains bracket (taxable income up to $94,050 in 2024 for married filing jointly). They sell non-qualified assets to make up what they need and pay much less tax on their gain. 

With alternatives to traditional retirement funds, you can spread out the taxable distribution and layer capital gains taxable dollars and non-taxable Roth dollars on top to make up your need in any year, rendering your income tax as efficient as possible.

It’s nice having those options.

That’s quite enough of that. You don’t have to memorize this stuff. That’s not your job, and I’ll admit, it can be complicated. But it’s good to understand why financial planners want you to have lots of tools in the toolkit to choose from. And that means starting to diversify these accounts by tax treatment in your 50s. You don’t know what you’ll need or what the tax code will look like in your retirement. This way, you have your tushy covered no matter what happens. Moving on.

Remember that there are no hard-and-fast rules for the best way to distribute a portfolio in retirement. Your plan, including your tax plan, is unique to you. You should have the option to blend or distribute all of one tax treatment at a time. If you choose the latter, in the spirit of “Mo Roth, Mo Better,” you should let that tax-free account grow as long as possible both for your retirement income and for your beneficiaries. (It’s far better for them if they inherit a Roth account than if they inherit a traditional account.) You’ll do this by loading it up with your growth assets in a strategy called asset location (the second idea I mentioned earlier).

And on that note, I’m going to give you a break and end my thoughts for this week.  Next week, I’ll elaborate on asset location to help make your income tax as efficient as possible. #WeRescueOurselves #NotYoungNotDone

Copyright © Madrina Molly, LLC 2024. All rights reserved.

The information contained herein and shared by Madrina Molly™ constitutes financial education and not investment or financial advice

Sherry Finkel Murphy, CFP®, RICP®, ChFC®, is the Founder and CEO of Madrina Molly, LLC.

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