What is Tax Planning? Here Are the Top 4 Ways We Help Clients Manage Taxes

Tax planning is one of the most significant ways we help clients maximize their retirement savings and overall financial health. For those at or near retirement, effective tax strategies can provide clarity, reduce unnecessary tax burdens, and increase the longevity of their portfolios. While the tax code can be complex, our expertise allows us to identify tailored opportunities to add value for our clients.

Here are four key areas where LifePoint Planning specializes in managing taxes for our clients.

1. Asset Location: Optimizing Your Investment Accounts

Not all accounts are created equal when it comes to taxes. Effective asset location means deciding which investments belong in taxable accounts versus tax-advantaged accounts like IRAs and 401(k)s.

Here’s how it works in simpler terms:

• Taxable Accounts are better suited for investments that generate lower taxes, like stocks or index funds. They're not suited for taxable bonds, CDs, and taxable money market funds.

• Tax-Advantaged Accounts are ideal for investments that may be taxed heavily, such as bonds or REITs.

This arrangement reduces your tax bill annually and compounds those savings over time.

According to Vanguard, this strategy can add significant value, potentially boosting returns by up to 0.60% annually.

The compounding benefits of getting asset location right make it a cornerstone of tax-smart investing.

2. Withdrawal Order: Making the Most of Your Money in Retirement

Did you know that the order in which you withdraw money from your accounts can affect how much you pay in taxes? Sometimes, drawing from taxable accounts first, tax-deferred accounts next, and Roth accounts last can often save money over time. Other times, it might make sense to take a different approach.

For example:

• Drawing from taxable accounts first usually allows you to show a lower amount of taxable income on your tax return. That might make it a compelling case to implement Roth conversions at a lower tax rate than you would otherwise. Additionally, your tax-advantaged accounts to grow longer, potentially compounding tax-free or tax-deferred.

• The graphic below shows two retirees with the same income goal. One takes most of their income withdrawals from their IRA, whereas the other chooses to withdraw from multiple different accounts.

Vanguard estimates that optimizing withdrawal strategies can add up to 1.20% annually in value. Similarly, Russell Investments quantifies the value of a tax-savvy withdrawal strategy as approximately 0.94% annually. These careful, deliberate strategies ensure clients can spend more confidently in retirement without worrying about unexpected tax surprises.

3. Roth Conversions: Turning Uncertainty Into Opportunity

Roth IRA conversions are a powerful tax planning tool, but their timing and implementation are critical. By converting portions of a traditional IRA into a Roth IRA during low-income years, you can take advantage of lower tax rates now and avoid paying higher taxes in the future.

When Roth Conversions Make Sense:

• Lower Current Tax Bracket: If you're in a lower tax bracket now and expect to be in a higher one during retirement, converting can lock in the current lower tax rate.

• Anticipation of Rising Tax Rates: With potential future tax increases, paying taxes now at a known rate might be advantageous.

• Desire to Avoid RMDs: Roth IRAs are not subject to RMDs during the owner's lifetime, allowing for greater control over distributions and potential tax-free growth.

• Estate Planning Considerations: Roth IRAs can be advantageous for heirs, as distributions are tax-free.

  
  

When They Don’t Make Sense:

• Higher Current Tax Bracket: If you're currently in a high tax bracket and anticipate being in a lower bracket during retirement, converting now could result in paying more taxes than necessary.

• Insufficient Funds to Pay Conversion Taxes: Converting to a Roth IRA requires paying taxes on the converted amount. If you don't have sufficient non-retirement funds to cover this tax liability, it might not be prudent to proceed. While not always a deal breaker, it should definitely be considered before making any conversions.

• Proximity to Required Minimum Distribution (RMD) Age: Individuals nearing or already subject to RMDs may find conversions less beneficial, as the tax impact of RMDs combined with conversion income could be substantial.

• Potential Impact on Medicare Premiums: Roth conversions can increase your taxable income in the year of conversion, potentially leading to higher Medicare Part B premiums.

• The graphic below illustrates 10+ items to consider before making Roth conversions.

The key is to develop a Roth conversion plan that adapts to changing tax laws and personal circumstances. For that reason, it's often better to treat Roth conversion analysis as a year-to-year exercise because various factors can shift significantly over time, impacting whether a conversion remains advantageous.

4. Managing Capital Gains: Balancing Today’s Taxes with Tomorrow’s Goals

Tax management is about striking the right balance for clients with large unrealized capital gains. Selling investments can trigger taxes on gains, making the timing of when to realize the gains increasingly important depending on multiple factors.

Here’s why capital gains planning is a year-to-year process:

• Income Fluctuations: A spike in income could push you into a higher capital gains bracket.

• Tax Law Changes: New legislation may create windows of opportunity or require strategy shifts. At the time of this writing, a Net Investment Income Tax (NIIT) of 3.8% could further impact whether or not realizing a gain makes sense.

• Life Events: Retirement, health expenses, or estate planning goals can all influence when and how to realize gains.

• Loss Carryforward: Sometimes clients will have capital losses from previous tax years that can be applied to future years. This can be a planning opportunity to realize gains at a current tax rate of 0% to offset a previous year's losses.

Tax planning involving taxable investment accounts allows us to adapt, be flexible, and help clients make the most of their investments while minimizing unnecessary tax burdens.

Tax Planning Isn’t One-Size-Fits-All

Tax planning is more than just saving money; it’s about creating a sustainable retirement strategy that works for your unique goals and circumstances. At LifePoint Planning, we specialize in understanding the complex tax issues that retirees face and providing personalized solutions that deliver real value.

If you’re ready to learn how we can help you make the most of your retirement, contact us to schedule a consultation today. Let’s create a plan that works as hard as you have.