I’ve worked in finance most of my adult life. Across various financial areas, I’ve realized the U.S. Tax Code has something to say about every detail of our lives.
You’ll face many tax situations on your financial journey: You may grapple with tax deductibility of home mortgage interest. You may have to compare LIFO and FIFO cost-basis methods. You may need to learn the difference between long-term capital gains and ordinary income taxes on your investments. But no matter what you face, you will have to deal with taxes at some point.
I’m not a CPA, but as a financial professional with high net worth clients, I’ve studied how taxes impact our financial lives.
Even if you’re in your 60s or 70s, it’s never too late to make improvements toward retirement plan taxes.Getty Images
However, I could have saved a lot of time and effort if I’d asked my dad.
Dad wasn’t a CPA either, but he was wise with his money and a great saver, like most in his generation. If I’d listened to my dad growing up, I would’ve had a head start.
Here are five things he would’ve taught me about taxes.
1. Don’t let taxes hold you back.
First, Dad would’ve told me rule #1: You’ll rarely escape paying taxes, so don’t let them hold you back.
Taxes go way back, even to the Egyptian era. (How do you think those pyramids got built?) Pharaohs of the time appointed scribes to collect tax on things as simple as cooking oil.1
In modern society, nothing’s changed, and taxes are as much a part of life as ever. But my dad would’ve pointed out how careful planning can cut unnecessary taxes. Many investors fail to do that.
Never be afraid to invest or earn money. You’ll never escape taxes; once you realize that, you’ll be free to become as successful as you can be. The inevitable extra taxes won’t worry you anymore.
2. There’s a big difference between tax evasion and tax avoidance.
Tax evasion sent Al Capone to prison. That should be enough for all of us.
Instead, Dad would’ve taught me to focus on minimizing or preventing unnecessary taxes. As the common saying goes, “It’s not how much you make; it’s how much you keep.” That’s what matters.
In retirement, pennies count more than ever. Paying unnecessary taxes will lead to premature spending of retirement assets.
There’s a phenomenon called reverse dollar-cost averaging. It can wipe out a retirement account in volatile market conditions if you’re taking too much income from it. Paying extra money toward unnecessary taxes only makes the problem worse.
3. Don’t put all your eggs in one tax basket.
Next, Dad would’ve told me, “When it comes to investing, don’t put all your eggs in one tax basket.”
You already know you should diversify your market portfolio to reduce risk exposure. But you may not realize how lacking tax variation impacts your income in retirement.
Today, many baby boomers entering retirement have saved in one tax-deferred account, like an IRA, 401(k), or 403(b). For the most part, that’s a beautiful thing. But over time, it leaves one entity in charge of how much you pay in taxes:
The government.
Think of it this way: You go to a bank to borrow $10,000. The banker says, “The bank is doing OK right now, so we’re going to cut you a check for that amount. Since we don’t need the money today, we’ll let you know in the future how much your payments and interest will be.”
Would you cash that check? Not a chance. You must know, upfront, the cost of borrowing money, which is the interest rate and payment terms.
That’s what we do when we defer taxes in our retirement accounts. The government can raise or lower tax rates every cycle, depending on how much money they need to collect.
Many people defer taxes during their profitable years, hoping to withdraw money in retirement at lower rates. But, because of changes like potential taxation of Social Security benefits and required minimum distributions, that hope is falling short.
4. Find a financial advisor who utilizes different taxable accounts to help you grow your wealth.
Let’s get back to my dad’s lessons. He would’ve told me to find a financial advisor who knows how to grow wealth in various taxable accounts. Once you retire, these accounts can complement each other in many tax environments.
Your accounts can generally be broken down into three types: taxable, tax-deferred, and tax-advantaged (tax-free). Taxable accounts include individual or joint brokerage and savings accounts and CDs. Tax-deferred accounts are products like IRAs, 401(k)s, annuities, and more. Tax-free accounts are Roth IRAs, Roth 401(k)s, and even permanent life insurance.
When I teach Retirement Survival classes, I ask my students which type they think I teach my children to use. The majority always answers, “Tax-free.” I smile and say, “Actually, I teach my kids that they need all three types of accounts.”
Why? Because tax rates change. The only way you’ll have control over how much you pay in future taxes is by having money in all three types.
5. It’s never too late.
Dad would’ve told me that if you’ve made mistakes in fending off unnecessary taxes, it’s never too late to do something about it.
Many clients I work with have fallen into the “tax trap.” They hold most of their savings in tax-deferred accounts. Every day, I help boomers carefully unwind potential tax threats in their retirement plans. Roth conversion limits, new 2017 tax brackets, and permanent life insurance all help with that.
Even if you’re in your 60s or 70s, it’s never too late to make improvements toward retirement plan taxes.
That’s what Dad would’ve said.
This content was brought to you by Impact PartnersVoice. Michael Avery does not provide legal or tax advice. Investment advisory services offered through RITE Financial Group, LLC, a Registered Investment Adviser. KY insurance license #707461. DT006224-0120