Tax Planning Concepts Part 1
Over the next several days or so, I am going to share two basic tax planning concepts that were featured in the monthly "Beyond the Number$" newsletter of Bowers Private Wealth Management. If you'd like to subscribe to "Beyond the Number$", and other key updates from Bowers Private Wealth Management, please click here.
As a CFP®, there are many way that I can help to potentially reduce your tax burden. Here is the first of a two basic strategies that can be used within a financial plan.
When you choose to defer taxes to future years, any earnings that you have will be able to compound without being reduced by income taxes. Because of this, your investment may grow at a faster rate than if your earnings were taxed each year. Also, in some cases, your deferred taxes can also be combined with an initial deduction for any contributions that you're able to add.
Tax deferral can be provided in different ways, but some examples include Qualified Plans (401Ks etc.), IRAs, Annuities, Health Savings Accounts (HSAs), Coverdell education savings accounts (ESAs) and 529 Plans. Tax deferral can also be available through the use of installment sale and like-kind exchange strategies.
Tax deferral can be the most beneficial when your tax is deferred until a time when your tax rate will be lower.
A basic example:
You make a nondeductible contribution of $5,000 to a traditional IRA. Assume you will be subject to a 28% income tax rate, both now and in the future. If you earn a 5% annual rate of return for 20 years, the $5,000 will grow to $13,266, with an after-tax value of $10,952. (If you made a deductible contribution of $5,000 to a traditional IRA and placed any tax savings from the deduction in a side fund, the after-tax value of the IRA plus the side fund after 20 years would generally be even greater.) If instead you simply saved $5,000 in an account that is taxable each year, the $5,000 would grow at a 3.6% after tax-rate to $10,095 in 20 years. This is $857 less than with the tax-deferral of making a nondeductible contribution to a traditional IRA. And just think, this is only the difference from one year and what should prove to be a conservative growth rate.
Tax deferral, and its potential benefits, are one of the many considerations that must be made when planning your finances.
In the next few days, I will share some thoughts on another basic tax planning concept.
Neither The Strategic Financial Alliance, Inc. nor its representatives or employees provide legal or tax advice. If legal or tax advice or other expert assistance is required, the service of a currently practicing professional should be sought.