How To Reduce Your Lifetime Tax Bill

If you like taxes, raise your hand!.... That's what I thought.

I believe it is reasonable to suggest paying every dollar of tax legally owed, but not a dollar more.

What do you think?

While you have probably heard why diversifying your investments is a good idea for generating income, you may not have heard why TAX diversification is equally important.

Below, you will find the three different "tax buckets" you can invest your dollars into, and how the withdrawals are taxed when you withdraw funds.

I find some people who put all their retirement savings into tax-deferred accounts, such as 401(k)s and Traditional IRAs. This strategy has some great benefits but may have some drawbacks later on. You get to delay your tax payment until withdrawal, usually between 10% - 37% for 2021-22 Federal Income tax rates.

Let's look at what someone's federal income tax bill would be if they wanted to withdraw $100,000 per year for income using only Traditional IRAs or 401(k)s. 

(This assumes a couple filing as married filing joint for 2021 taxes, has no other income, and is taking the standard tax deduction.)

Okay, not bad I suppose. This could be a great tax bracket for the couple, especially if they were in a much higher bracket during their earning years. 

However, if this couple had invested into some other tax "buckets" or made tactical shifts of funds over to Roth accounts years prior before needing the income, they could be paying even less in taxes and potentially look something more like this:

In this basic example, the example couple could save approximately $48,000 in taxes over the course of just 10 years!!

I'm sure they could find something to do with those saved funds rather than pay taxes...

HOW IT WORKS

The reason why the couple in the second example had a lower tax bill is due to WHERE the income came from. 

• Qualified withdrawals & subsequent growth from Roth accounts are tax-free since the tax was already paid years ago when the contributions were made
• Brokerage, or non-retirement, accounts can be a good place to hold investments that do not generate many dividends. A more favorable capital gains rate (always lower than regular income tax rates, historically) applies to ONLY the gains from the investment
• In this particular example, the couple is in a low enough tax bracket to sell investments that generate capital gains and pay 0% on the gains
• Real estate held outside of retirement accounts can also be very tax efficient. The $30k of income from our example could also be from rental income, which is often significantly offset by depreciating the value of the building each year

Structuring investments, income, and accounts does take time & planning several years beforehand to ensure you will be getting the highest amount of after-tax benefit possible.

If you would like to schedule a free, no-obligation call to see if your current or future tax bill can be reduced, click the link below!

SCHEDULE A TIME HERE

Please note this was simply a case study and not a specific recommendation for an exact withdrawal strategy. There are many factors to consider when crafting a strategy such as this, and every situation is different.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.