Does Your Financial Plan Account for Higher Taxes?
Most people start financial planning with the goal of growing their finances through savings and investments. But financial planning is not limited to increasing your wealth alone. It is also about reducing your cash output. Essential expenses, impulse purchases, interest rate payments, etc., can increase your cash outflow and reduce your savings. While these can be avoided, there is another cash outflow that can considerably lower your savings and returns and is also hard to avoid – tax.
Tax planning is essential. Tax is charged on every penny you earn. Right from your income and stock investment returns to your property, inheritance, retirement withdrawals, and more, it is hard to ignore tax. Tax evasion is a crime, and missing tax payments can lead to legal hassles that can be hard to get out of. However, you can adopt certain tax and financial planning strategies to lower your tax output. To learn more about different tax and financial planning strategies that you can employ, reach out to a professional financial advisor who can advise you on the same.
However, in order to do so, it is important to first understand how taxes might have an impact on your financial plan. Keep reading to find out.
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What impact do taxes have on your financial planning?
The government charges tax on every dollar you earn or receive. This implies not only your income from your job or business but also the money you may inherit from a parent or grandparent, the return from investments, such as stocks, mutual funds, etc, is taxed. It also includes your 401k and Individual Retirement Account (IRA) withdrawals from traditional accounts. Further, you also pay tax on property. Some states may also have more taxes than others.
Evidently, the higher the tax, the more you have to lose. Tax can shrink your net-worth and come in the way of your future financial goals. It also affects your returns and may turn them ineffective in the face of inflation. The inflation rate in the U.S. reached 9.1% in June 2022. This means that for your investment returns to retain their value in the future, they must offer a return higher than 9.1%. Further, if the tax rate is higher than the inflation rate, you may not make any real profits.
As of 2022, here are the income tax slabs in the country:
| Taxable income for single tax filers | Tax rate |
| Within $10,275 | 10% of the taxable income |
| Over $10,275 but not over $41,775 | $1,027.50 plus 12% of the excess amount over $10,275 |
| Over $41,775 but not over $89,075 | $4,807.50 plus 22% of the excess amount over $41,775 |
| Over $89,075 but not over $170,050 | $15,213.50 plus 24% of the excess amount over $89,075 |
| Over $170,050 but not over $215,950 | $34,647.50 plus 32% of the excess amount over $170,050 |
| Over $215,950 but not over $539,900 | $49,335.50 plus 35% of the excess amount over $215,950 |
| Over $539,900 | $162,718 plus 37% of the excess amount over $539,900 |
| Taxable income for married filing separately | Tax rate |
| Within $10,275 | 10% of the taxable income |
| Over $10,275 but not over $41,775 | $1,027.50 plus 12% of the excess amount over $10,275 |
| Over $41,775 but not over $89,075 | $4,807.50 plus 22% of the excess amount over $41,775 |
| Over $89,075 but not over $170,050 | $15,213.50 plus 24% of the excess amount over $89,075 |
| Over $170,050 but not over $215,950 | $34,647.50 plus 32% of the excess amount over $170,050 |
| Over $215,950 but not over $323,925 | $49,335.50 plus 35% of the excess amount over $215,950 |
| Over $323,925 | $86,127 plus 37% of the excess amount over $323,925 |
| Taxable income for married filing jointly | Tax rate |
| Within $20,550 | 10% of the taxable income |
| Over $20,550 but not over $83,550 | $2,055 plus 12% of the excess amount over $20,550 |
| Over $83,550 but not over $178,150 | $9,615 plus 22% of the excess amount over $83,550 |
| Over $178,150 but not over $340,100 | $30,427 plus 24% of the excess amount over $178,150 |
| Over $340,100 but not over $431,900 | $69,295 plus 32% of the excess amount over $340,100 |
| Over $431,900 but not over $647,850 | $98,671 plus 35% of the excess amount over $431,900 |
| Over $647,850 | $174,253.50 plus 37% of the excess amount over $647,850 |
| Taxable income for the head of household | Tax rate |
| Within $14,650 | 10% of the taxable income |
| Over $14,650 but not over $55,900 | $1,465 plus 12% of the excess amount over $14,650 |
| Over $55,900 but not over $89,050 | $6,415 plus 22% of the excess amount over $55,900 |
| Over $89,050 but not over $170,050 | $13,708 plus 24% of the excess amount over $89,050 |
| Over $170,050 but not over $215,950 | $33,148.50 plus 32% of the excess amount over $170,050 |
| Over $215,950 but not over $539,900 | $47,836.50 plus 35% of the excess amount over $215,950 |
| Over $539,900 | $162,218.50 plus 37% of the excess amount over $539,900 |
As you can see, the highest tax bracket is 37%. Further, there are income tax proposals that, if implemented, may increase the highest marginal income tax rate to 39.6%. Not only this but the Long-Term Capital Gains (LTCG) tax rate can also be increased to 39.6% for incomes over $1 million. Currently, the highest LTCG tax rate is only 20%. Here’s the table for it:
| Long-term capital gains Tax Rate |
Taxable income for single tax filers | Taxable income for married filing separately | Taxable income for married filing jointly | Taxable income for the head of household |
| 0% | Up to $41,675 | Up to $41,675 | Up to $83,350 | Up to $55,800 |
| 15% | $41,675 to $459,750 | $41,675 to $258,600 | $83,350 to $517,200 | $55,800 to $488,500 |
| 20% | More than $459,750 | More than $258,600 | More than $517,200 | More than $488,500 |
What to do if you fall into a high tax rate slab?
Higher tax rates can evidently hurt your financial growth. However, there are some tax and financial planning tips that can help lower taxes. Here are some of them:
1. Use tax-advantaged accounts
Tax-advantaged accounts can help you lower your taxes and maximize your profits as long as you use them wisely. Tax-advantaged accounts refer to accounts that offer tax exemption or tax-deferred growth. For instance, a 401k account is a tax-advantaged account. This company-sponsored account offers two options – the traditional and the Roth. The former offers tax-deferred growth where your contributions are tax-exempt, but your withdrawals are taxed in retirement. The latter taxes you in the present, while your withdrawals in retirement are tax-free if made after the age of 59.5. Just like the 401k, you also have other tax-advantaged accounts like the IRA. An IRA works more or less like a 401k. However, it is not employer-sponsored. Instead, you can open it on your own with a broker, credit union, insurance company, or bank. It offers a traditional and a Roth version, exactly like the 401k.
A 529 savings account is another example of a tax-advantaged account. A 529 is an education savings account that can be used for the higher education expenses of your children. It offers tax-deferred growth, so your contributions grow free of federal and state income taxes. Moreover, anyone can contribute to a 529, such as parents, grandparents, and legal guardians, so the account can be highly effective in saving for a child’s education, irrespective of the tax breaks. A 529 also offers tax-free withdrawals as long as the money is used for qualified education expenses.
You can also use a Health Savings Account (HSA) for tax-advantaged growth. HSA is a savings account primarily designed for healthcare expenses. Your contributions are 100% tax-deferred. Moreover, your withdrawals are free from any state or federal tax as long as they are used for qualified medical expenses.
Tax-advantaged accounts can help you save a lot of tax if you use them correctly and are mindful of their rules and regulations. If you fall into a higher tax slab, you can invest in these options from a young age to lower your tax. Just be careful to only use the accounts for qualified expenses and adhere to the withdrawal limitations. Having said this, you must also select these accounts based on your requirements. Tax savings are only one of the benefits of these accounts. Their primary uses are distinct and should be used for their intended purpose only.
2. Pick a state with low tax:
The state in which you reside can also have a considerable impact on your taxes. If you already fall in a higher tax bracket, it may be better to settle in a state that has low state tax rates. If not, you will risk losing your retirement income and may even outlive your savings. Tax rules can differ from state to state. So, make sure to compare the taxes and make a decision after careful consideration. For instance, the state of Alabama does not tax Social Security benefits in retirement. In addition to this, the state also does not tax pension and retirement income for teachers, firefighters, government and military employees, etc. Likewise, Florida, Tennessee, and New Hampshire do not tax your income, pension, or Social Security benefits. So, these can be good options for retirees. Washington also does not tax your income from pension, Social Security benefits, etc., but the state levies a property tax. So, you may have to take a call after carefully evaluating your assets.
Some states may not entirely eliminate taxes but can still offer some relief. For instance, Illinois allows you to remove Social Security benefits and pension from your federal adjusted gross income (AGI) and then taxes you. This means you will be taxed on a lower tax slab. Mississippi also offers a similar provision and excludes income from IRAs and 401(k)s, as well as Social Security benefits from taxable income.
As of 2022, you can consider the following states for low taxes in retirement:
- Alaska
- Nevada
- Washington
- Florida
- Alabama
- Illinois
- Mississippi
- Pennsylvania
- South Dakota
- Tennessee
- New Hampshire
- Wyoming
- Texas
3. Plan your estate well:
Estate taxes are another cause of concern, especially for high net-worth individuals who may have very large estates. However, the government does offer some gift tax exemptions that can help you lower your tax liability. As of 2022, the federal estate tax threshold limit is capped at $12.06 million for individuals. This has been increased from $11.7 million in 2021 but may likely be decreased in the future. Some tax proposals are asking for a new tax limit of $3.5 million. If implemented, this will be a drastic drop. So, this may be the right time to use this option and save significant money. At present, the limit is further doubled for married couples, at $24.12 million.
If you avail of these limits, you only pay tax on the value of the estate that is higher than the threshold. Here are the latest tax slabs for the same:
| Taxable amount over the threshold | Estate tax rate | Tax paid |
| $0 to $10,000 | 18% | $0 base tax + 18% on the taxable amount |
| $10,001 to $20,000 | 20% | $1,800 base tax + 20% on the taxable amount |
| $20,001 to $40,000 | 22% | $3,800 base tax + 22% on the taxable amount |
| $40,001 to $60,000 | 24% | $8,200 base tax + 24% on the taxable amount |
| $60,001 to $80,000 | 26% | $13,000 base tax + 26% on the taxable amount |
| $80,001 to $100,000 | 28% | $18,200 base tax + 28% on the taxable amount |
| $100,001—$150,000 | 30% | $23,800 base tax + 30% on the taxable amount |
| $150,001 to $250,000 | 32% | $38,800 base tax + 32% on the taxable amount |
| $250,001 to $500,000 | 34% | $70,800 base tax + 34% on the taxable amount |
| $500,001 to $750,000 | 37% | $155,800 base tax + 37% on the taxable amount |
| $750,001 to $1,000,000 | 39% | $248,300 base tax + 39% on the taxable amount |
| More than $1,000,000 | 40% | $345,800 base tax + 40% on the taxable amount |
What happens to your tax liability with proper financial planning?
Proper financial tax planning can lower your tax liabilities by a great margin. These strategies are not complex or elaborate. They are simple measures that you can take at the right time and save money. For instance, availing the estate tax exemption will, in most cases, eliminate taxes completely. Most people have estates valued at less than $12.06 million and $24.12 million for joint properties. So, you can practically cut your estate taxes to zero. The same can be said for tax-advantaged accounts like the 529 savings account, HSA, and others. You only need to ensure you use the money for qualified expenses, and you are good to go.
To summarize
Tax and financial planning should go hand in hand. This way, you can create a steady savings fund without worrying about any future liabilities. Picking the right accounts from the very start and putting some thought into where you live can help you save money in the long term. So, do not ignore these important steps.
Further, if you fall into a high tax bracket, you can always consult a financial advisor in your area and understand the different ways to lower your taxes. Use WiserAdvisor’s free advisor match service to find highly qualified and vetted financial advisors who can guide you on the same. Answer a few questions about yourself and get matched with 1-3 financial advisors that are suited to meet your requirements.
To know more about how you can effectively manage your finances by taking tax liabilities into consideration, visit Dash Investments or email me directly at dash@dashinvestments.com.
About Dash Investments
Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.
Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.
CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.
