How to Lower Your Taxes

With the end of the year approaching,?Falcon Wealth Advisors ?Co-Founder Bittner, CRPC?, joined me on?Upticks ?to discuss how you can lower your taxes this year and beyond. As a bonus, make sure to tune into the episode to hear about how Cory and I are now intentionally using our time each Wednesdays, and it may be worthwhile to consider how you could use your time more intentionally, too. A summary of my conversation with Cory is below.

Jake:?As we enter the fourth quarter of the year, it’s a good time to look at strategies and tactics to lower your taxes. Our team at?Falcon Wealth Advisors ?takes tax planning seriously and I think it’s a capability that helps separate us from other wealth advisors. The first topic I would like to talk about is withdrawal strategies.

Many Falcon Wealth Advisors clients have three types of accounts:

• A brokerage account, which is funded with after-tax dollars. Investors have to pay capital gains taxes when trades are made in this account.
• Traditional IRAs, which are funded with pretax dollars. Investors have to pay ordinary income taxes when withdrawing from traditional IRAs.
• Roth IRAs , which are funded with after-tax dollars. Investors don’t have to pay any taxes when they withdraw from Roth IRAs.

As you can see, all three of these types of accounts are taxed differently. Cory, how are clients able to take advantage of this?

Cory:?We often work with clients to map out exactly where their income will come from each year. We will plan to pull some money from taxable accounts and other money from after-tax accounts in an effort to keep their taxable income as low as we can. Keeping your taxable income low in retirement can help prevent your Social Security benefits from being taxed at a higher rate. A lower taxable income can also help keep the cost of your Medicare premiums lower.

Jake:?And we can also help you plan for Required Minimum Distributions (RMDs), which are what the government requires you to withdraw from pretax retirement accounts beginning at age 72. The less money you have in a pretax account, like a traditional IRA, the lower the potential RMD. And because RMDs are taxed as ordinary income, they can cause your taxable income to rise.

Having money in all the types of accounts we have discussed, as well as a savings and checking account, gives you and our team some flexibility to plan and strategize on how to keep your taxable income as low as possible. I would recommend you meet with our?Falcon Wealth Advisors ?financial planning group to look at your taxable income for this year and discuss how we can limit it from rising any more than it has to. For example, if you have a surplus of cash built up in your checking account, we may encourage you to spend from that and pause your traditional IRA distributions for the remainder of the year.

If you’re not a?Falcon Wealth Advisors ?client but want to learn more about our tax planning capabilities, please contact us. While we are not tax professionals, we feel we deliver added value to our clients through tax planning. And we can work in concert with your tax professional.

Cory:?And just because a specific tax planning strategy makes sense this year, that doesn’t mean it will next year, as rules and regulations change regularly, and your financial plan evolves. That’s why we discuss tax planning when we meet with our clients at least once a year.

Jake:?Well said, Cory. Let’s now talk about?asset location , which involves purposefully putting certain types of investments in certain types of accounts, all in an effort to lower your tax liability. For example, you could put stocks in a brokerage account because the capital gains taxes you have to pay on them are typically lower than ordinary income taxes. What are your thoughts on asset location?

Cory:?I’m stating the obvious, but it makes sense to invest stocks with the highest growth potential in a Roth IRA, as they can grow tax free—and you don’t have to pay income taxes on Roth IRA distributions. Of course, conversely, we avoid investing bonds in Roth IRAs, as history shows us their growth rates don’t typically keep up with stocks. With that being said, if interest rates continue to rise and you buy a bond that yields 7-8%, it could make more sense to consider placing in it a Roth IRA.

Jake:?And you wouldn’t want to put a tax-free municipal bond in a Roth IRA or traditional IRA, as the interest earned on those bonds is tax free. It’s a red flag for us if we meet with a potential client and discover their advisor has tax-free bonds invested in an IRA.

It goes without saying that if you have a traditional IRA, Roth IRA and brokerage account with?Falcon Wealth Advisors , those three accounts won’t be comprised of the exact same investments. Instead, because we’re utilizing the asset location strategy, we’re able to tailor each account to take advantage of the tax benefits associated with it. As longtime readers know, we use individual stocks and bonds rather than investment products like mutual funds.

I’d like to discuss?Net Unrealized Appreciation ?(NUA), which is a complex tax strategy that involves taking shares of your company’s stock from your 401(k) plan at work and investing them in a brokerage account. What can you share about NUA, Cory?

Cory:?Taking advantage of NUA in the appropriate situation can allow an investor to pay capital gains taxes on highly appreciated company stock. As we discussed earlier, capital gains taxes are typically lower than ordinary income taxes.

Jake:?If you work at a publicly traded company and have the company’s stock in your 401(k), I recommend talking to our team?before?you retire and?before?you sell that stock. We may be able to utilize NUA and help you receive a more favorable tax treatment on that company stock. It’s something we’ve helped clients with for many years.

We’ve talked about?Roth IRAs , but many clients of all ages are looking to take advantage of a Roth’s tax benefits. Why is this?

Cory:?A Roth IRA is a useful tool because assets grow tax free inside the Roth account. A Roth IRA is funded with after-tax dollars, but once funds are in the account, they can grow tax free and you don’t have to pay taxes when you make withdrawals from the account after age 59.5.

Jake:?I think many accountants are incorrect when they encourage their clients to focus on contributing to pretax retirement accounts, like a traditional IRA or a 401(k) at work. When you contribute to pretax accounts, you’re deferring the tax liability on those dollars—you’re not eliminating them. When you go to withdraw from that pretax account in retirement, you will have to pay ordinary income taxes on every dollar you pull. Additionally, we talked about RMDs, and if the vast majority of your retirement savings is in a pretax retirement account, this could lead to you being required to withdraw more money than you want or need after age 72. In turn, these RMDs could push your taxable income into a higher bracket than where you want to be.

The government doesn’t require RMDs for Roth accounts, however, so it’s not too late or too early to explore a Roth account. If you have a lot of money in a pretax IRA, we may even be able to?convert some of that money into a Roth IRA . At Falcon Wealth Advisors, we’re focused on lowering your tax liability in the long term rather than just this year. And we recently purchased software that allows us to scan in your recent tax returns and explore strategies like Roth conversions that may make sense for you.

Cory:?Yes, I think we’ve had a lot of success focusing on both the short and long term as we tax plan for clients, and we work to make sure we are on the same page as their tax advisor, when possible.

Jake: Indeed. Let’s next talk about charitable giving. The itemized standard deduction is higher now than in previous years, meaning many people who donate to charities can’t as easily write off those deductions. At?Falcon Wealth Advisors , we help our clients take advantage of?donor advised funds , which allow you to invest money one time—while potentially pushing you over the standard deduction threshold—and distribute it to a favorite charity over the course of several years. It may make sense to do this in a year in which you receive a big bonus at work or earn a large return from stocks. It’s a way to lower your tax bill this year while setting up a planned giving approach. We believe it makes sense for anyone who is charitably inclined and donating to a 501(c)(3) charity to explore a donor advised fund.

Cory:?You can not only invest money in a donor advised fund, you can also donate appreciated stock, allowing you to potentially avoid capital gains taxes on that appreciated stock.

And?health savings accounts ?(HSAs) belong in the financial planning discussion, as they can help lower your taxes. When you invest in an HSA, you can withdraw from that account in the future to pay for qualified medical expenses. In some ways, an HSA offers the benefits of a pretax account and a Roth IRA. You can deduct HSA contributions from your taxes?and?the money inside an HSA grows tax deferred, like a Roth. Your withdrawals are tax free as long as they are used on qualified medical expenses.

Jake:?It’s worth noting that to be eligible to contribute to an HSA, you have to be enrolled in a high-deductible health insurance plan. So not everyone is eligible. But if you are eligible, we should discuss HSAs. In my opinion, the proper way to leverage an HSA is to invest in it and let the funds grow for years so you can use them to pay for medical expenses later in life.

Let’s finally discuss?tax loss harvesting , which is relevant for investors who have money in a taxable brokerage account. Tax loss harvesting allows you to sell a stock that’s down in your brokerage account to offset any gains in the account. This in turn lowers your tax liability.

Cory:?It’s a strategy that can make sense in a year like this one when stocks are down. Still, we don’t recommend selling stocks and realizing losses for the?sole purpose?of lowering your tax liability. We don’t want to spend a dollar to save 30 cents, and our primary goal is to achieve positive returns. But tax loss harvesting can be a silver lining when the market is down.?

Jake:?Indeed, we don’t want to sell a stock just to take advantage of tax loss harvesting, and then miss out on the market’s next upswing.

Thanks, Cory. If you would like to learn more about tax loss harvesting and all our tax planning capabilities, please contact?Falcon Wealth Advisors ?today. This is an important time of year to think about your taxes, so if you’re ready to be proactive, reach out to us. You can contact me directly at?[email protected] .

Clients choose to work with us to enhance their financial literacy and explain exactly what?their?financial plan means to?them.

Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.