Why You Should Plan Taxes 2 Years at a Time

PREPARATION is key to seamless tax planning. 📝

Michael Baum, CFP®, RICP® breaks down why you should think ahead and plan your taxes TWO YEARS at a time. 

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Transcript

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Welcome to You and Your Money. Empowering you to Plan Well, Invest Well and Live Well. Joining us today is Michael Baum, vice president and associate financial advisor at Weiss, Hale and Zahansky Strategic Wealth Advisors. Now let's get to our topic of the day, the benefits of planning your taxes two years in advance. Let's start at the very beginning. Why is planning your taxes in advance so important in the first place? Well, great question. When planning ahead for your taxes accomplishes a bunch of things, really. First, it allows you to be proactive and strategic to maximize tax savings. Second, it eliminates that stress and rush of that last minute tax prep. I think we're all probably familiar with. And third, planning early helps you to avoid mistakes and errors on your return. Those are, you know, the big ones. So that makes a lot of sense. Nobody wants mistakes on their taxes. But what specifically are the benefits of planning two years out instead of one? Well, looking out two years gives you even more advantages and an opportunity to both plan and invest well in ways that maybe only one year won't let you. So you can review new tax laws that are taking effect or are slated to take effect a few years into the future, because they do usually give us a little advance notice on any major tax changes. And that leaves you time to start adjusting your strategy well in advance. You can also be smarter with investment planning and charitable giving to help reduce your tax liability. Sounds like there are some major perks to planning further ahead. Walk me through some of the key benefits in more detail. Absolutely. Planning two years out allows you to get organized early and avoid errors on your returns like you. It takes away that deadline stress by giving you plenty of time to get everything pulled together. And I know from personal experience, you know, there's going to be forms coming in at all different times of the year. And you never quite know, you know, where to put that. So, you know, get organized and pull all those things together and do it well in advance. And that's going to help you make sure that you're taking advantage of all the available deductions and credits with some proactive planning. And you'll have time to adjust for any major life changes like retirement, marriage, divorce or moving. Those are all going to have a tax impact in one way or another. Two year planning also lets you review new tax laws taking effect. Start incorporating those changes into your strategy and the further you can look ahead. The more you can plan for setting aside funds for a future tax liability or set up an estimated payment plan if you need to do that. Just to continue here when in planning two years ahead will allow you to be strategic with investments to maximize their tax efficiency. For instance, you can take advantage of tax loss harvesting opportunities or realized gains when it's most advantageous to you. And if you're charitably inclined, the amount and timing of your charitable gifts can be planned strategically to make sure you receive the maximum tax benefit. So I just want to kind of close by saying if a lot of these concepts I've listed thus far are things you'd be uncomfortable tackling yourself, there's yet another reason that planning ahead will be beneficial. It gives you the time to seek help if you decide you want or need professional guidance. Michael, what are some of the practical first steps listeners can take to start planning their taxes two years in advance? Well, there are a few good starting points are to plan well by pulling your returns from the last 2 to 3 years and reviewing things like your income sources, your deductions and your tax rates over this time. This will give you some insights into, you know, what I like to call your tax profile. Sort of your base, you know, tax situation that you have historically. And that can help you to think about what it would look like if you had, you know, more income or less income or investment income or if you had some changes in life that were going to drastically change, you know, what you owe on taxes. So getting that together and having a good sense of where you typically stand can help you predict future changes to your situation a little bit further out. Next, I would say make notes on any anticipated late changes coming up. Right. So you can you can take those into account because those could drastically affect your taxes. If you have any major assets, you're going to sell like a home. You may have some capital gains associated with that or you may not if you're retiring or moving. All of those are going to change, you know, where your income comes from or you know what your expenses look like and you're going to need to make some adjustments for that. So factor those in early two years, early if you can, and then you're going to be well ahead of the game. And lastly, I would say use the IRS tax withholding estimate or tool to project your income and federal withholding needs for the next two years based on your situation. So you may be having too much or too little withheld from your paycheck, in which case you can adjust how much you have withheld with your employer accordingly. And this is a big one for me, as I see a lot of people go into tax season with no idea whether they're going to owe more in taxes or get a tax refund and it just doesn't have to be that way. You know, ideally you just pay the right amount of taxes along the way and neither owe nor get any money back. Excellent. Some very practical tips listeners can start applying immediately. Now, Mike, can you explain how working with a financial advisor can help somebody plan their taxes? Two years ahead? Yeah, of course. So financial advisors will take a look at your full financial picture from a tax planning perspective. They can recommend strategies to optimize your situation across your investment account, your retirement savings, homeownership, charitable giving and more. And so the insights from a financial advisor on how all these different pieces fit together can help identify the most tax efficient approaches for each person's unique circumstances. Mike, tell me what it's like when you talk to some of the people that you deal with when you run this concept of planning your tax plans two years in advance. There's a fair amount of people, and I can probably raise my hand on this, too. You start to get those tax forms in the mail about this time of the year and well, some of us kind of put them aside for a month or two and things like that. And then you do your thing, but you're doing it one year. You're not doing it two years in advance. So what is the reaction by some of the clients that you have who hear this concept? Do they buy into it and maybe save themselves some money in the long run? Yeah, I mean, it is it is a bit of a foreign concept to people because they just don't you know, they're so used to thinking, well, I don't even know, you know what? I'm going to be able to get back or what? I'm going to own taxes until the moment I file. But that's sort of the point. So when you're working with investment accounts and when you're working with people on a comprehensive financial plan, it really pays to have their tax situation in mind at all times and to be thinking about those things, you know, well ahead of time, especially around events. I think retirement is the big one when you're going to be going from, you know, receiving a paycheck every day or every every couple of weeks to, you know, needing to generate income from whatever your nest egg is comprised of. You know, you don't want to be strategic and you don't want to think about, okay, my income level is going to go from point A to point B and it's going to be made up of all these different sources now. And their tax treatment might vary. And we're kind of going to get to that in a little bit. But, you know, that's where you can get more strategic and think further ahead and you can say, okay, we're going to do a little bit of this right before year end in year one. And then a little bit more right in the beginning of year two and straddle over to tax years. And so that's kind of where it comes into play and where we can get really strategic in practice. A lot of people get giddy when they know they've got a tax refund coming, and for that reason, a lot of people like to file early, get things in now. My philosophy on this has always been, though, that I don't want to get money back from the government because if I do, that means they've been holding on to my money for 12, 13, 14 months interest free. I'm okay with the idea of paying a little. I don't want to pay a lot, but paying a little. When it comes to April the 15th, because then I got that money for a year and change. What's your thoughts on the refund versus paying the government money when you pay your taxes? Well, I mean, I'm with you. I definitely don't want to have to I don't want to get a bunch of money back that I could have been, you know, investing or saving or using for my ongoing expenses throughout the year. And it truly is an interest free loan to the government. So, you know, people get into a habit of of being excited about that, like you said, or, you know, planning a vacation when they get their refund every year. And to me, that's that's just that's somebody who's a prime candidate for you know, more education and more planning in their in their in all of their finances so that they could be maximizing their wealth and their income all along the way rather than relying on this sort of lump sum that might feel good but that, you know, you didn't need to you didn't need to get. I think the danger with owing taxes and not paying enough along the way that some people just may not have that, you know, extra money lying around to pay the tax bill. And I know you mentioned just paying a little bit in taxes. And I think that's where you have to be careful, because if you drastically underpay your taxes, there could be penalties associated with that as well. So it's better to be kind of right on or maybe slightly under to your point, but you got to make sure you have the money to make that check, to pay that check when the when the taxman comes to collect. So. What's your philosophy on refunds to a certain level, either a, getting a check back and cashing it and spend it on stuff or be using that refund money and putting it toward next year's taxes? Well, I mean, putting it towards next year's taxes is in a sense giving the government the interest free loan again. You know, so if we were going to be strategic with it, I'd say if you have money that's coming to you, there's going to be some way for you to put that to work for yourself and you benefit from, you know, the interest or having that money on hand. Now, in theory, you know, let's say it amounted to one extra paycheck. You know, you could take that now and then direct, you know, one extra paycheck throughout the year towards maintaining your mortgage early or, you know, something else that you have on your to do list a vacation or fixing something around your house or something like that. So I would say use that money and be strategic. And that's something that, you know, you need help with. You know, that's obviously what a financial advisor can help you do. That's a very good answer. Very good point. You touched a moment ago on retirement. Expand more on how retirement and investment planning tie into tax planning. Sure. So the way your investment mix, so you may have retirement accounts and non retirement accounts, you might be saving in, you know, an employer plan, but also saving in some sort some type of a brokerage account. The way that you invest and save can really impact your tax situation both now and in the future. So in terms of investing, planning ahead, obviously it's critical. Different types of accounts receive different tax treatment. And in most most circumstances, there are penalties for withdrawing from retirement accounts before the age of 59 and a half. So if you're saving and investing in an account with with plans to draw from that account before 59 and a half, you should, you know, really carefully consider which which investment vehicle most suits your needs. And along the same lines, the investment strategy within each account should be in sync with the tax treatment of that account. For example, index funds may be more tax efficient in non retirement accounts because they generate less capital gains than mutual funds. And on the retirement side, I guess deciding when to make Roth versus traditional IRA contributions can have a big impact on your taxable income both now and in retirement. So maximizing for on key contributions always a good idea. It's going to, you know, help you build up your nest egg. But you know, what should it be with after tax dollars or should you use, you know, pretax deferrals to lower your taxable income? Now, a financial advisor can help analyze these pieces holistically. And then, of course, like I alluded to earlier, when you start to when you reach retirement and start to need to draw on your portfolio, a financial advisor can help create that retirement income plan that allows you to live the lifestyle you want and achieve your goals in the most tax efficient manner possible. That makes sense. Taxes don't exist in a vacuum. What other factors roll up into comprehensive tax planning? Well, we touched on a couple of these earlier, but a few of the big ones are charitable giving. So strategic charitable giving can maximize your tax deductions. If you're somebody who already gives to charity on a regular basis. There may be ways to garner an even bigger tax benefit by just by making the same gifts you're already making. Managing homeownership tax breaks, there's a lot of potential tax benefits to homeownership that can be optimized through careful planning. And I'm talking about, you know, going beyond just, you know, mortgage interest deduction or state and local tax deduction. So those are the big ones. And lastly, tax aware investment management, this is the practice of considering a client's tax liabilities throughout the portfolio construction and management process to proactively maximize after tax returns. So I like to just kind of put this in a really simple terms for people. What you earn is important, but what you keep matters more. So as we discuss why you should plan taxes two years at a time, it might be easier, I would think, for people to do that if they have a steady income. But what about people who have a variable income? They make more money in the wintertime because they plow snow and things like that than they do in the warmer months of the year. Does this apply to everybody or is it more difficult for people who have money that they make more at certain times of the year than other times of the year? I think the same opportunities are going to exist for those people. And because, you know, it's still it still comes down to planning ahead as far as you can and saying maybe not exactly what your, you know, income level is going to be or exactly how much you'll earn. But in some of those jobs you talked about, you do have some variability or control over, you know, when you get paid and and how you know how that's going to hit your taxes in which tax year specifically. You know, you mentioned someone who plows snow. I mean, they can choose to, you know, build their customers in the spring and have that roll into the next tax year or, you know, they can structure that differently and get the income rolling in currently. And so that's a that's a pretty good example, actually, of where somebody in that position may have some control over, you know, which tax year is going to be a big year or, you know, or can they defer things and reduce their taxes in any specific year? Well, that would be a year. And we have snow, which we haven't had too much of this year. Any final thoughts for our listeners on planning taxes ahead, Mike? I would say just remember those key benefits. So if you plan ahead and plan two years out, especially, you're going to reduce your stress, you're going to maximize your savings, you're going to avoid errors, and you're going to be able to adapt to any changes in the tax code early, taking small steps like organizing documents and using the IRA estimates tool are going to be, you know, great ways to get ahead of the game and make sure you're not missing out on anything. Great advice, Mike. Thank you for sharing your expertise on tax planning today. My pleasure, Wayne. It's great to be here today. Absolutely. And to our listeners, if you seek guidance or wish to discuss your financial strategy or any of the key topics we mentioned on the show today, don't hesitate to reach out to Weiss, Hale and Zahansky Strategic Financial Advisors. Visit their website whzwealth.com or call them 860-928-2341 to schedule a complimentary consultation. Thanks for listening to You and Your Money. Find even more episodes, videos and other resources at whzwealth.com. Until next time, live well. Weiss, Hale and Zahansky Strategic Wealth Advisors offer securities and advisory services through Commonwealth Financial Network member FINRA/SIPC, a registered investment advisor. Fixed insurance products and services offered through CES Insurance Agency. They practice at 697 Pomfret Street, Pomfret Center, Connecticut, 06259. They can be reached by phone at 860-928-2341. Weiss, Hale and Zahansky Strategic Wealth Advisors do not provide legal or tax advice. The tenured financial services team strives to support clients in achieving their financial life goals. For more information regarding wealth management and customized financial planning with Weiss, Hale and Zahansky Strategic Wealth Advisors, please visit www.whzwealth.com.