Tax Planning: There’s More Than Meets the Eye

by: Richard A. Anderson

Nobody likes paying taxes. Even though taxes are necessary to keep our schools open, communities safe, roads clean, and governments running, it’s not a fulfilling experience to see a percentage of your hard-earned income or investment gains vanish into thin air. With that being said, there’s no way of escaping taxes (without risking legal repercussions, of course), but that doesn’t mean there aren’t things we can do throughout the year to reduce the amount of taxes you ultimately end up paying.

There are typically two times taxes come up during the year. The first is at the end of the year when we want to know what we can do to reduce taxes owed for the current year. Are there any last-minute things I can do to receive a tax deduction or tax credit? The second is around the tax filing deadline, we are either perturbed by higher-than-expected tax liabilities or pleasantly surprised by tax refunds. Whatever the situation, we want to know what we can do differently in the current year to reduce taxes owed in the future.

We often talk about how financial planning and investment management go hand-in-hand; your financial plan is the GPS that guides your investment portfolio. The combination of financial planning and investment management is often referred to as comprehensive wealth management. However, you can’t have comprehensive wealth management without incorporating tax planning. Tax planning is the third leg of the comprehensive wealth management stool. The best investment returns or financial plans can easily be derailed by poor tax planning. That is why tax planning is so important.

When it comes to tax planning, everyone’s situation is unique. Therefore, it’s impossible to say with 100% certainty the steps we take will help reduce the taxes you end up paying at the end of the year.

In our investment management process, we typically take the following actions:

· Tax loss harvesting throughout the year. Often, we capture losses that can be used to offset future realized gains. But we can also harvest capital gains if you are in a low tax bracket in a given year and you expect to be in a higher tax bracket in the future.

· Tax-smart rebalancing to minimize realized capital gains.

· Selecting the right assets. This can be utilizing municipal bonds for investors in high tax brackets or not investing in asset classes where the tax cost outweighs the return and diversification benefits.

· Asset location to divide assets between taxable and tax-advantaged accounts to maximize your portfolio’s after-tax returns. Tax inefficient assets are preferred in tax-advantaged accounts, while tax efficient assets are preferred in taxable accounts.

· Utilize tax sensitive investment managers.

In our financial planning process, we typically advise the following actions for those who may be eligible:

· Maximize contributions to retirement accounts, whether it’s an IRA or employer retirement plan.

· Nondeductible traditional IRA contributions and Roth conversions.

· Contribute to 529 accounts for college savings.

· Contribute to health savings accounts (HSAs).

· Gift to Donor Advised Fund utilizing a bunching strategy.

These actions are the cornerstone of our financial planning and investment management processes because they generally apply to all investors. Where the real value is added is by incorporating these processes with assets and income not related to your investment portfolio. It’s considering all of the aforementioned items in light of the impact on:

· Potential estate taxes

· Taxation of social security

· Taxation of Medicare benefits

· Property tax freezes

The best way to accomplish our goal of incorporating your total tax picture with your financial plan and investment portfolio is collaboration with your tax preparer. For many of you, we have established a relationship with your accountant to maximize the efficacy of our tax planning efforts.

For those of you who we have not established a relationship with your accountant, we would greatly appreciate an introduction, preferably after the April 15th tax filing deadline, so that we can improve the services we are providing you.

Please feel free to reach out to a member of the HIGHLAND team with any questions you may have.