What Tax Planning Is and How It Can Help Make Reaching Your Goals Easier

a senior couple at home considering their financial plan

Key Points

Tax planning is the process of reviewing your financial situation and structuring your affairs in a tax-efficient manner to minimize your tax liability.
Tax planning can involve a range of strategies, such as deferring income, taking advantage of tax credits and deductions, and utilizing tax-advantaged investment accounts.
The benefits of tax planning include reducing your tax bill, increasing your net income, and freeing up more funds to help you reach your financial goals.
Tax planning can also involve creating a long-term strategy to minimize taxes over the course of your lifetime, such as converting traditional IRA or 401(k) accounts to Roth accounts, which can help you reduce your taxes in retirement.
To create an effective tax plan, it’s important to work with a financial advisor or tax professional who can help you identify tax-saving opportunities and develop a customized plan that meets your unique needs and goals.

Taxes suck but they don’t have to suck as bad if you’re smart.

Taxes are one of life’s certainties, and no one likes giving up some of their hard-earned cash. With a thoughtful tax plan for the year and the next 5 years, however, it’s possible to pay less in taxes or receive a larger refund at the end of the year.

While it’s impossible to avoid taxes wholly, there are numerous tools you have in your tool belt to make planning for a more tax-efficient future, easier.

The most common tools you have to save money on taxes both today and in the future include:

What is tax planning? Image is of a woman preparing her taxes.

How Having a Thoughtful Tax Plan Can Benefit Your Retirement Plan

Saving for retirement is difficult for nearly everyone because life gets so expensive and, if you add on the tax bill that our government charges us, it can make it even harder. Luckily, the government realizes how hard it is for us to afford life so they’ve created investment accounts that have major tax advantages. The accounts that I’m referring to are:

Traditional IRAs
Roth IRAs
Health Savings Accounts
401k
Roth 401k

These five types of accounts aren’t always appropriate for everyone but they can definitely help with making saving for retirement easier for the right people.

Once that money has been deposited into any of these accounts, it can gain value based on interest or investments, and what’s more, you won’t be charged taxes on that money until you remove it from the retirement account (or possibly at all).

These accounts don’t let you avoid taxes entirely but they can definitely help lower your bill both today, in the future, or both for many people. For example, if you contribute to your company’s pretax 401k plan… you get a tax deduction which could lead to literally thousands of dollars being saved on taxes in the year that you do the contribution.

Once you’re retired, you’ll have to pay tax on all the money you withdraw from your 401k but likely at a much lower tax rate (assuming you have your mortgage paid off and a simpler life).

Tax Planning Starts With Goals Setting

If you ask 1000 multi-millionaires what tax rate they’d like to pay, you’ll likely hear 0% from over half of them. While that’s a little humorous, it’s also not a smart goal because it’s unrealistic. No one can guarantee you a 0% tax rate in retirement without wasting tons of money trying to do so.

Setting a prudent, aggressive goal for tax planning can help you more thoughtfully plan your tax future. For a lot of our clients, we aim for the 12% marginal income tax bracket but for some, we have to aim much higher (25%+).

Once you’ve set your goal, you ask yourself what resources you have to make it happen.

Do you have a Roth 401k? Rental properties? A small business?

If you anticipate an increase or decline in your income during the next few years, start catering your financial plan to the upcoming shifts ahead of time, according to CNBC. Figure out if it’s best to pay taxes on that increased income right now, or if you should try and put it all into tax-deferred accounts that may incur taxes later on.

A Good Tax Plan Considers Every Aspect of Your Life To Ensure Nothing Is Missed

Taxes affect so many parts of your life that you may forget different ways to save. If you fail to consider the tax implications of a big financial decision, you could end up wasting a lot of money. The tax laws surrounding home sales can be particularly painful for uninformed buyers and sellers, according to MarketWatch contributor Bill Bischoff. For example, people can get an exemption on capital gains taxes on a home sale if they file jointly with a spouse.

This can result in massive savings for couples, but far too many people fail to consider this factor when they list their homes for sale. By speaking with a financial professional before taking any financial action, you can prevent yourself from accidentally missing out on significant tax exemptions.

Should You Take the Standard Deduction or Itemize?

Whenever you file your taxes, you have the option of taking the standard deduction given to all filers or creating a custom deduction by listing your expenses for the year. The hard part is figuring out what you can include as an itemized deduction or not be permitted to. If you’re a business owner (sole prop, partnership, LLC, etc.) you’ll have a bit more freedom surrounding what you can and cannot include as a deduction because so many qualify as business deductions. If you live a simple life working a 9-5 job, you may be better served to take the standard but it really depends on what you did throughout the year.

Either option can offer better savings, depending on your financial situation, so you’ll want to evaluate exactly how your financial life changed during the past 12 months. With proper tax planning, you can make your financial life much easier and pocket additional money along the way by knowing what receipts to keep and when not to.