The years leading up to retirement are frequently filled with several opportunities to minimize taxes that, if not implemented, can never be recaptured. Unfortunately, many people wait until about one or two years before retirement before getting serious about retirement planning, only to later regret their delay.
While there’s nothing magic about a 10-year time frame, we like to use that as a starting point to emphasize that this is about being very forward-looking and not just considering the current or upcoming year. Though we tend to find that this is especially valuable during the last 10 years or so before retirement, regardless of what life stage you are currently in, long-term tax planning may provide benefits to both you and your family that can last well into the future.
Are You Missing Out?
In our opinion, tax minimization opportunities may be missed because of the relatively narrow focus of different professionals. Tax preparers (e.g., Certified Public Accountants or CPAs) may not necessarily collect all information regarding your assets, liabilities, retirement goals, and future projected needs. Additionally, investment managers who focus primarily on investments may not necessarily look at all the variables of your comprehensive financial situation.
However, all these different variables are generally essential when developing strategies aimed at minimizing taxes. As a result, many tax preparers and investment managers do not provide the type of advanced planning required to take advantage of the different tax strategies available.
Take A Team Approach to Your Wealth Management
We believe the solution to capitalizing on opportunities to minimize taxes requires a team approach:
- Have a knowledgeable, professional prepare your taxes, whether this person is you or a CPA who ideally also has a background in financial planning.
- Engage a second financial professional or team who is knowledgeable on tax minimization strategies, collects information on your assets, liabilities, retirement goals, and future projected needs. This person/team should make forecasts using reasonable assumptions that uncover potential opportunities and landmines.
Once these are identified, they should help you develop and implement a strategic financial overview (more on this below) that incorporates tax minimization strategies for at least the next 10 years. They should also help you monitor the financial overview regularly and update it at least annually to account for your changing financial situation and new opportunities. When this is done in coordination with one’s tax preparer, powerful strategies designed to minimize taxes may be effectively employed consistently.
Create a Financial Overview
What do we mean by “financial overview”? A financial overview is ultimately a plan (in document form), both comprehensive and consistent, which should include the following:
- All pre-retirement income sources
- Projected future retirement income, including Social Security, pensions, investment income, business, and rental income, and part-time work
- Retirement plan contribution opportunities, including Health Savings Accounts, Flexible Spending Accounts, work retirement accounts, IRAs and Roth IRAs, non-qualified accounts, and other applicable investment options
- Estate planning variables, including asset titling, beneficiary designations, potential uses of trusts, life insurance, business continuity, etc.
- Future charitable intentions
Each of these areas can have major tax implications, either for better or for worse. Whether you maintain this financial overview yourself or employ a financial professional, it is important that the person doing the maintenance is trained in identifying tax minimization strategies so that valuable opportunities are less likely to be lost.
Update Your Plan Annually…or, When Life Happens
Once your financial overview is in place, it is important to revisit the plan annually and modify it as necessary as life situations change. An annual tax analysis is important since tax laws change, income needs can often vary from one year to the next, and there are several significant age-based circumstances that you will likely encounter throughout your lifetime. Some of the many occurrences that may change with time that will likely affect your tax strategy include:
- Health insurance changes at retirement and at age 65 when Medicare becomes available
- Claiming Social Security
- Starting required minimum distributions at age 70 ½
- Changing tax laws and income tax rates
- Charitable giving
- Receiving inheritances
- Paying off a mortgage
- Retirement plan contribution limits and availability, and governmental changes to these
- Special one-time purchases for new vehicles, vacation home purchases, home improvement, children’s weddings, grandchildren’s education, etc.
- The purchase or sale of a business
- Pension eligibility and benefit levels
- Conversion opportunities from IRAs to Roth IRAs
An Example: Charitable Stacking
As just one of many examples of how coordinated, advance planning can provide tax savings, let’s consider charitable giving. There are usually more efficient ways available to donate beyond writing out a check. These include donating appreciated investments, gifting required minimum distributions from IRAs and a strategy our firm calls “Charitable Stacking.”
Charitable Stacking involves donating several years’ worth of future expected charitable donations into a charitable fund prior to retirement, during years when you are likely in a higher tax bracket and can realize the tax benefits when they may be the most valuable to you. Then the monies are donated out of the charitable fund to charities over time.
These strategies may be especially attractive in light of the recent tax legislation that was passed since many people who have been receiving deductions for charitable giving may no longer be itemizing deductions. However, they may not be able to be taken advantage of without proper advance planning.
Final considerations for your plan
There are also many considerations that have more to do directly with how your investments are managed, such as determining when to realize capital gains, tax-loss harvesting (selling assets intentionally at a loss) to help offset other taxes, and avoiding triggering wash-sale rules (rules that could postpone tax benefits of realized losses).
With a long-term tax strategy, you can also seek to optimize your contributions and withdrawals depending on how different investments are taxed. For example, it may be beneficial to take more money out of highly-taxed investments in years when you are in a lower income tax bracket and to take more out of investments that don’t create extra taxation in years when you expect higher than normal income tax rates. The key is to be proactive and to modify your contributions and/or investment income streams as necessary each year to accommodate for that year’s tax implications while keeping a close eye on future income needs.