By: Arash Navi, CFP®, CPA, Controller & Wealth Manager
Our goal is to help our clients build and grow their wealth and tax planning plays an important role in this process. We recommend that you mark your calendar to review your finances in the first week of October, annually. Take this time to review your income for the year from employment, businesses, investments, or any other sources. This will help you project your tax liability ahead of time and allow your financial advisor or tax accountant to find strategies to reduce your tax burden. Implementing this consistently and reducing your tax burden annually will have a compounding impact over the years and increase your retirement nest egg. Here are a few tax planning strategies to keep in mind:
IRAs and Retirement Plans
Take full advantage of tax-advantaged retirement accounts. By contributing to Traditional IRAs and employer-sponsored retirement plans such as 401(k) plans, you can reduce your taxable income and lower your taxes. For 2021, you can contribute up to $19,500 to a 401(k) plan ($26,000 if you’re age 50 or older) and up to $6,000 to a traditional IRA ($7,000 if you’re age 50 or older).
Roth Conversions
If you are in a lower tax bracket this year and expect your income tax rate to increase in the future, you may want to consider a Roth IRA conversion. You can convert all or part of your pre-tax retirement account into a Roth IRA and pay the taxes now at a lower rate. The funds in your Roth IRA will continue to grow tax free, and you will have more income flexibility in retirement.
Charitable Donation
If you are charitably inclined, you should plan your donations in advance to ensure you maximize the tax benefits. For those over age 70.5, you may want to consider Qualified Charitable Distribution (QCD), where you can transfer up to $100K from your IRA to a charity. This method not only reduces your Required Minimum Distribution (RMD), but the distribution is also excluded from your taxable income.
Tax Bracket Management
The IRS uses a progressive tax system which means as your income grows, it is subject to a higher tax rate. Therefore, it is important to know in which of the seven federal tax brackets you will fall into. In your high-income years, you may want to reduce your tax liability by increasing your retirement contribution or utilize a tax-loss harvesting strategy. On the other hand, in low-income years, you may want to consider Roth IRA conversions, accelerate income recognition, or postpone deductible expenses.
Tax planning should be part of every individual investor’s financial and retirement plan. There are many strategies available for individuals and business owners, but it requires proper planning throughout the year. If you’d like to learn more about tax planning strategies unique to your personal circumstances, feel free to Talk With Us!
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