The Tax Planning Toolbox

Money can be elusive – always in sight and always on the move. While you might be saving, investing, spending, or inheriting it, as soon as you catch up to it Uncle Sam is right around the corner – palms out and demanding his “fair” share. It’s a hot topic and a big reason why news outlets love to dramatize the subject (it also doesn’t hurt that it brings in viewers and ad revenue). But by the same token, it’s all the more reason that proper tax planning for retirement is as important as ever.

The tough part is making choices today for the unknown tomorrow. Will a new administration move forward with proposed tax increases? Is your current tax bracket lower than what you project it to be in retirement? While the future is murky, there’s enough tools at our disposal to encourage us to save toward major life goals: retirement, healthcare, education, emergency spending, charitable giving, and wealth transfer.

However, it’s up to us to dig in that tool box and make the best use of these tactics. Today, let’s take a look at some of the most familiar tax planning strategies available. In my next piece, we’ll cover how we help our clients incorporate them into and across their financial plans.

Tax Planning for Retirement

Whether you pay now or pay later, you’ll still owe the tab. But the good news about saving for retirement is that whether or not you delay payment, you still get to defer the taxes in any of the tax-favored accounts available to us.

There are a number of employer-sponsored plans (like the 401k, 403b and SIMPLE IRA) as well as individual IRA’s you establish outside of work. For both, there are Roth (pay now) and traditional (pay later) structures available.

In either of these, your dollars grow tax-free while they remain in the account. This helps your retirement assets grow more quickly than if they were subject to the ongoing taxes that regular accounts incur along the way (such as realized capital gains, dividends, or interest paid). Think of it as a “shield” for your money.

From there, the tax treatments for the different types of retirement accounts start to differ:

For some, you can make pre-tax contributions, but withdrawals are taxed at ordinary income rates in the year you take them.

For others, you contribute after-tax dollars, but withdrawals are tax-free—again, with some caveats.

Each account type has varying rules about when, how, and how much money you can contribute and withdraw without incurring penalties or unexpected taxes owed.

Tax Planning for Healthcare

The Healthcare Savings Account (HSA) offers a rare, triple-tax-free treatment to help families save for current or future healthcare costs. What are the “triple-tax free treatments”?

• You contribute to your HSA with pre-tax dollars
• HSA investments grow tax-free
• You can spend the money tax-free on qualified healthcare costs

If you qualify, it’s not a bad deal. Plus, you can invest remaining HSA dollars for later use, years down the line (as long as it’s on qualified healthcare costs).

What’s the catch? Most notably, HSAs are only available as a complement to a high-deductible healthcare plan to help cover higher expected out-of-pocket expenses.

Employers also can offer Flexible Spending Accounts (FSAs), into which you and they can add pre-tax dollars to spend on out-of-pocket healthcare costs. However, FSA funds must be spent relatively quickly, so investment and other tax planning opportunities are limited.

Tax Planning for Education

529 plans are among the most familiar tools for catching a tax break on education costs. It’s fairly straight forward:

• You fund your 529 plan(s) with after-tax dollars
• Those dollars can then grow tax-free
• The beneficiary (usually your kids or grandkids) can spend them tax-free on qualified educational expenses

An added benefit is that the amount of your contribution (subject to federal limits) counts towards your lifetime gifting limits while lowering your taxable estate. More on that later.

Tax Planning for Giving

The Donor-Advised Fund (DAF) is one of the simplest but most effective tax planning breaks for your charitable giving. Instead of giving smaller amounts each year, you can establish a DAF and fund it with a larger, lump-sum contribution in one year.

You then recommend the DAF distributes to your charity of choice over future years. Combined with other deductibles, you might be able to take a sizable tax write-off the year you contribute to your DAF—beyond the currently higher standard deduction.

Tax Planning for Emergencies

Part of any financial plan is setting up and growing your “rainy day fund.” While this is usually as simple as setting aside cash in a savings account, it doesn’t always have to be so boring. There are a variety of tax-friendly incentives to facilitate this fund, typically used to offset crisis spending (like the kind many of us have been experiencing during the pandemic). These include state, federal, and municipal savings vehicles along with targeted tax credits and tax deductions.

Tax Planning for Heirs

Last but not least, there are a number of trust vehicles, insurance policies, and other estate planning structures to help families leverage existing tax breaks to efficiently transfer their wealth to future generations. With recent negotiations over the tax treatment of inherited assets, families may need to revisit their estate planning in the years ahead.

In fact, whether times are turbulent or not, there’s always an array of best practices we can implement to help reduce our lifetime tax bill. We’ll cover how to leverage these tax planning tools in the next installment.