As we get ready to enter the fourth quarter, we often start thinking about making wise tax decisions before the calendar flips. I doubt you ever think that paying more taxes this year would be the right answer. In fact, one of my most common calls is clients asking, “how do I pay less tax this year?”. This thought process is prevalent in the accounting world. Ultimately, why wouldn’t you want to defer taxes? The simple answer is you may be able to save taxes if you pay at a lower rate today than in the future. Kiplinger had a good article on this topic that got me thinking about their logic and some application to how we help people through our Purpose-Built Planning.
The tax rate issue is a simple math equation. An example would be, if I can pay a 10% tax rate this year versus a 25% tax rate in the future, why wouldn’t I take that 15% savings even if I have to pay it this year. The decision and understanding of the tax rate you will be subject to is complicated and can be a gamble. You may be asking yourself, “how can my tax rate change that much?” There are numerous scenarios that could change your rate such as:
- Expiration of the Tax Cuts and Jobs Act – The cuts to tax brackets that were initiated under Trump are scheduled to sunset after 2025. Effectively, they will go back to the brackets that existed before the tax cut.
- Increased Income – Your income may be low this year due to loss of a job or business losses but will increase in future years. You should be taking advantage of that low-income tax year.
- Change in filing status – If you divorce or a spouse dies in the future, your tax rate will change significantly as you change from a married-filing-jointly status to a single status. This is one of, if not the largest, tax impacts I’ve seen happen to my clients. In most cases, the widow, for example, has no idea that her tax liability is about to change due to this devastating event in her life.
- National Debt – At some point, we will have to deal with our national debt. There are many ways to help lower it from cutting spending to raising taxes. I’ll give you one guess as to how Washington will likely try to combat it.
Choosing to pay taxes in a low-income tax environment may also allow you to create different buckets of investments from non-qualified investment accounts to ROTH IRAs. As we use our Purpose-Built Planning process to create your roadmap, these varied buckets will give us options through retirement to access money in the most tax efficient way possible.
This can all seem very complicated because it is. Do you feel comfortable making these decisions? Most people do not, and you often need a professional to help you navigate these costly choices. If you need us, we can be there to help.