Let's face it; no one enjoys paying taxes. Often I’m asked about managing money in a way that avoids taxes altogether. I’m here to tell you that there is no secret sauce. I think that people have the wrong idea about their taxes. It is not a matter of avoiding them altogether but rather paying them at the lowest rate possible. I’d like to put a few tax-planning strategies on your radar for when tax planning season comes around. This is by no means a comprehensive list, but rather a few key concepts that I think are often overlooked:
A Roth conversion is when you transfer money from your tax-deferred retirement account (Traditional IRA, 401(b), 403(b), etc.) into a Roth. The difference between the two being when taxes are paid. With Traditional accounts, taxes are paid when you take money out, whereas Roth accounts are funded with money that has been taxed. The benefit is that Roth accounts will not be taxed again (as long as you meet a few requirements). Sometimes paying taxes at the lowest rate possible means paying taxes now. This could be a great strategy for someone who has a period of time when their income is lower. I also use this with my clients in times of volatility when investments may be down.
Qualified Charitable Distributions:
This is possibly one of the most under-utilized strategies out there. My colleague, Brandon, wrote a great article about QCDs that goes into detail: (https://fsgmichigan.com/blog/easy-tax-savings-you-are-likely-missing-dont-overlook-qcds). The footnotes read: if you are 70 ½ years old (the IRS likes half birthdays), you can utilize QCDs for your charitable contributions. Even if you are not itemizing, doing a Qualified Charitable Distribution from your IRA allows you to make those philanthropic contributions tax-free. This could be used for tithes at your local church or for financial support to a charity that you’re passionate about.
There are a number of cases where this rule can apply, but for this article, I’m talking about one circumstance in particular. If you have a non-qualified annuity, you should be mindful of your cost basis and your taxable gain. With these annuities, if you started with, say, a $50,000 investment and that account grew to $80,000, then you have $30,000 of gain. Any money that you withdraw, comes from the gain first and is fully taxable. However, if you transfer funds into another annuity or a long-term care policy, this is called a 1035 exchange and is tax-free. Benefits from a long-term care policy are not taxable, which means you can use your non-qualified annuity to pay premiums directly to your long-term care policy, thus utilizing that money tax-free.
Qualifying Widow(er) Tax Status:
My colleague, Kyle, did a video talking about what he calls “the Widow’s Penalty” (https://fsgmichigan.com/vlog/educational-moment-the-widows-penalty), where becoming a widow or widower actually increases your tax burden. However, there is a qualifying widow(er) tax status to offer some relief. A surviving spouse may be able to effectively double their standard deduction and benefit from the higher joint tax status income brackets for up to two years after their spouse has passed. If you are filing as a qualified widow or widower, it may be a good time to consider Roth conversions as well.
Tax planning is incredibly specific to the individual. If you think you may benefit from one of these strategies, I highly encourage you to reach out to your financial advisor and accountant. It’s important that your financial planning team is in communication as a whole and is working cohesively for your benefit. Of course, if you are in need of a financial advisor, please contact our office at 800-804-0420.
Written by: Justin Meyer
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