By Caurie Putnam
BridgeTower Media Newswires
Unless you have an extension for your federal income tax return, your 2021 tax return should have been put to bed last month. That doesn’t mean you should stop thinking about taxes until tax season comes around next year, though. Local professionals in the field recommend proactive tax planning be a part of your overall wealth management strategy 365 days of the year, every year.
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What is proactive tax planning?
Simply put, proactive tax planning is a comprehensive process that incorporates forward-looking tax-efficient measures into your financial plan.
With this approach, each part of your financial plan is examined through a tax lens so you can have an educated and focused tax strategy in place.
“Proactive tax planning is a part of comprehensive financial planning,” said Megan A. Rinaudo, a partner with Thorley Wealth Management, Inc., an independently owned and operated financial advisory firm in Pittsford. “The goal is to pay the least amount of taxes legally possible based on an understanding of each client’s circumstances ... something that everyone should think about no matter what tax bracket they’re in.”
Vast areas in which proactive tax planning can be beneficial include such choices as the timing of large purchases and sales (especially real estate), how you save money for your retirement, your amount of charitable giving and your approach to estate planning.
Connor Holly, first vice president and financial advisor with Sage Rutty and Company, Inc., a Rochester-based financial services company founded in 1915, explains that another important aspect of proactive tax planning is asset location.
“Proactive tax planning includes an awareness of what you’re investing in,” said Holly, who has worked in the financial planning field for 12 years.
“Some investments are more tax-friendly than others, like municipal bonds, ETFs [exchange traded funds] and individual stocks. You want to make sure you’re owning the right things.”
Holly also recommends Roth conversions as an integral part of proactive tax planning. That’s when you convert existing retirement plans such as a 401(k) or traditional IRA to a Roth IRA and take advantage of its range of tax benefits for yourself and your beneficiaries.
“Due to the SECURE Act Roth accounts are more tax-friendly than they’ve ever been for beneficiaries,” said Holly about the federal act (formally known as the Setting Every Community Up for Retirement Enhancement) that was passed in 2019.
Among other things, the SECURE Act increased the age of minimum retirement account distributions from 70.5 to 72 and stipulated that inherited retirement account distributions must be taken within 10 years.
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Proactive tax planning vs. tax prep
Proactive tax planning is not the same thing as tax preparation, which is the annual period when you gather your financial documents like 1099s, W-2s and charitable receipts in preparation to file your taxes.
“Tax preparation is getting ready to file your taxes – it’s the mad dash to the April deadline,” said Jarrett Felton, managing director of Invessent Wealth Management, LLC, a Rochester-based boutique wealth management firm. “Tax preparation is more reactive in my opinion, whereas tax planning is proactive and should be an everyday thing for business owners and at least quarterly for those that are W-2s employees.”
Tax preparation can be done independently, with a CPA, tax preparer or even an enrolled agent, whereas tax planning is often accomplished through a team approach. This type of planning, at a minimum, should include your CPA, investment advisor, attorney and insurance agent. In short, you’ll need different specialties yet coordinated advice.
“As a fiduciary, I look at people’s lives from a holistic perspective,” said Felton, who has worked in the field for 18 years. “I ask questions ranging from ‘What’s your credit score?’ to ‘How does your estate work?’ When it comes to tax planning I don’t tell or teach people how to file, but I do make them aware of the tax risks.”
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The secret sauce of tax planning
The management of short and long-term capital gains is also a part of proactive tax planning – something Felton calls the “secret sauce” of the comprehensive financial plan because not all gains and losses are treated the same.
Although it notes there are exceptions, the IRS defines a long-term capital gain as an asset you hold for more than one year before you dispose of it. Conversely, if you hold it for one year or less, your capital gain or loss is short-term.
Per IRS.gov.: “The tax rate on most net capital gain is no higher than 15% for most individuals. Some or all net capital gain may be taxed at 0% if your taxable income is less than or equal to $40,400 for single or $80,800 for married filing jointly or qualifying widow(er).”
While the word “losses” in a financial discussion can generate concern, when it comes to capital gains, that’s not necessarily the case.
“Capital gains are a good thing because your money made money,” Rinaudo said. “Nobody likes to pay taxes on capital gains, but you need to look at the big picture. If you’re paying capital gains it means your money is working for you and is growing.”
Tax-loss harvesting is also a capital gains strategy where “loss” isn’t a bad thing. This process has the potential for investment losses to become tax benefits and is especially appealing in today’s down market. Along with being attuned to asset location and Roth conversions, Holly counts tax-loss harvesting as the third most important part of tax planning.
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Closing thoughts
Rinaudo, who has worked in the financial services industry for close to a decade, likes to use the adage: “Don’t let the tax dog wag the investment tail” when it comes to tax planning. In other words, don’t lose sight of your long-term investment goals to minimize taxes in the short term.
Tax planning is a highly individualized endeavor and can change throughout the lifespan depending on major events like the birth of a child, purchase of a home or retirement. Tax planning can also be impacted by changes in tax laws, regulations and rates, which Rinaudo says are “always evolving.”
Likewise, Felton says: “The accumulation of wealth is an ever-evolving journey. From my perspective, the people who make their financial planning a priority, move with intention and stay proactive are the ones who have a much better chance at financial success. Being forward-focused will go a long way, but you have to have the right people surrounding and guiding you.”
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Caurie Putnam is a Rochester-area freelance writer.
