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Financial Planning Strategies that Can Help at Tax Time and Beyond

April 1, 2019 | Sam Rouman

Every year at tax time, perhaps even more so this year, each of us is presented with an opportunity to assess our financial plans as we go through the process of completing our taxes.

Did you discover anything surprising? How about your withholding? Did you come up short and have to write a check? Or perhaps you had too much withheld and you are receiving a larger than expected check, which is great, except you could have been saving or investing this money all year long, or using it to pay off debts and more.

Here are a few things to consider this month as you finish up your taxes and prepare for summer.

Diversifying your accounts by tax status:

There are clear benefits to diversifying your accounts. There are three broad categories of financial accounts from a tax standpoint:

  1. Tax-free – Roth IRA or Roth 401(k) accounts
  2. Tax-deferred – traditional IRA, 401(k) and 403(b) accounts
  3. Taxable – brokerage/investment or bank accounts

By maintaining some percentage of your investments and savings in these various accounts you create flexibility with how to meet your cash flow needs during retirement in the most tax-efficient manner. Keep in mind that each individual’s allocation to these accounts can vary dramatically, so just because you can spread your investments out over these accounts, does not mean you should. You should consult your personal financial and/or tax professional for help, if needed.

In the tax-free category, cash is invested and it grows over time. When you start to withdraw the funds, your investment and the growth of the investment can be withdrawn tax-free. The most typical type of account in this category is a Roth IRA. For the most part, when you take money out of a Roth account, it is going to be tax-free. You can always take the money you put in, but you may have to wait a few years to take out the growth, but most people draw money out after retirement.

Tax-deferred accounts are most commonly known as traditional IRAs, 401(k) or 403(b) accounts. Usually, you put cash into these with money that has not been taxed. Cash is put into the account and invested, and the account grows without any taxes until the funds are withdrawn. It is likely that your tax rate will be lower when you withdraw the money, but not always, so be sure to consider your tax situation first. The two advantages are: no income tax on the money when it goes in, and no income tax while the account is being accumulated. If you think your tax rate when you take the money out will be higher than when you put the money in, you may want to consider an after-tax option like a Roth IRA first, or perhaps putting some of your money in pre-tax and some in after-tax.

Taxable accounts are quite simple and straightforward, and there are no tax rules governing when and how you can take money out. Taxable accounts, however, can have income and investment gains that are taxable right away. You often can’t control the income, but you usually can control the gains. This is done by being deliberate about when you sell a position in your account that has risen in value. Some of these gains may be taxed as long-term capital gains which are often taxed at a lower rate, and some may be taxed as regular income, so you need to keep an eye on this. Long-term capital gains and qualified dividends are taxed at rates that vary from zero percent to 23.8 percent and those taxes are incurred when you sell at a gain or receive dividends in a taxable account.

Your financial and/or tax professional should know the nature of the gains that are anticipated and how those gains will be taxed and place investments in the best tax “location.” Investments that are most likely to generate long-term capital gains should be held in taxable accounts where they can benefit from the lower tax rates applied to those gains. Comparatively, bond investments that are likely to generate ordinary income are better suited to be housed in tax-deferred accounts.

The bottom line: if you maintain a mix of taxable, tax-deferred and tax-free assets you give yourself an opportunity to meet cash flow in the most tax-efficient manner and potentially handle changing tax laws over time.

Want to learn more about investment strategies or other ways you can get your 2019 tax planning off on the right foot? Start here.

The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Investment advisory services and fee-based planning offered through BerganKDV Wealth Management, an SEC Registered Investment Advisor.

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