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Income Taxes: Does It Pay to Plan?

Zoe Team and Philip W., CPA, CFA (Zoe Network Advisor)

Nov 3, 2019

5 min read

A financial advisor reviewing a plan with two clients at a table

Key Takeaways

Procrastination is a primary barrier to effective financial and tax planning.
Early tax planning allows for more opportunities to optimize deductions and manage liabilities.
Establishing consistent financial habits can mitigate the stress caused by seasonal tax deadlines.

Frequently Asked Questions

Why do people procrastinate on tax planning?

Psychological factors like seasonality and the complexity of financial tasks often lead individuals to delay essential planning.

What is the benefit of early tax planning?

Proactive planning provides more time to identify tax-saving opportunities and avoids the rush and errors associated with last-minute filing.

How can a CPA help with my taxes?

A CPA provides expert guidance to navigate complex tax laws and implement strategies that reduce your financial burden.

Procrastination is a woe many of us strive to understand and manage. Seasonality may have quite a bit to do with why we put things off. In fact, 76% of shoppers say they put off making holiday purchases right up until Christmas. While you can put gift shopping off until you start hearing holiday jingles, and reap the benefits of a few extra sales, it could be well-worth your time and money to jump on spring, and “tax season,” early!

Most individuals only think about taxes during filing season – which largely runs from January to April. Yet, this approach has a significant downside. It’s reactive rather than proactive. It doesn’t allow you to plan. If you want to lower your tax bill, think about taxes throughout the year. It can save you money.

Why? When you gather information to prepare your return, the year is already over. While you can increase your retirement account contributions before filing your return, you can’t do much else to lower your tax bill.

For investors, taxes take on even greater importance. Taxes and investing are essentially joined at the hip. Paying lower taxes on your investments should add to your portfolio’s value.

If you want to lower your tax bill, consider some of the following suggestions.

Pay Lower Taxes with Charitable Planning

Are you charitably inclined? Donate appreciated stock. It allows you to avoid capital gains taxes and claim a deduction. For example, if you want to donate $25,000 to your favorite charity, give them appreciated stock, not cash. If you paid $10,000 for a security that is now worth $25,000, you’ll get a $25,000 tax deduction and won’t pay any taxes on the gains. If you sold the stock and then donated the cash, you would pay capital gains taxes on the $15,000 gain ($25,000 less $10,000).

Once you pass the age of 70 ½ you must take required minimum distributions (RMDs) from retirement accounts such as IRAs. Assume you want to donate $10,000 to the charity of your choice. If you receive your RMD and then donate the $10,000, the contribution is considered an itemized deduction. In 2019, the standard deduction for a couple filing a joint return is $24,400. Depending on your tax facts, you might not get any tax benefit from this donation. Consider a qualified charitable contribution (QCD) by making the donation directly from your IRA to the charity. If you make a QCD, the RMD is excluded from your income. That’s a better outcome.

Tax-loss Harvesting to Lower Your Bill

Unfortunately, some investments decline in value. Consider selling securities when you have a loss. These losses can offset taxes owed on any gains realized from other securities you sold during the year. Losses offset gains of the same type (short- or long-term). You can also realize up to $3,000 of excess losses each year and carry the balance over. One caveat. Be aware of the wash-sale rule. Taxpayers can’t claim a loss if they buy the same or a similar asset within 30 days of selling the same or similar security.

ETFs Rather Than Mutual Funds

Gains mutual funds realize from selling securities are distributed to the fund holders. Plus, mutual funds must sell underlying securities to free up cash for redemptions.

On the other hand, the buying and selling of exchange-traded funds occur through an exchange, making them more tax-efficient. As a result, the ETF sponsor is not required to redeem shares whenever an investor wishes to sell, or issue new shares each time an investor wants to buy. If you own an ETF, your dividend income will still be taxed, but you won’t receive unexpected capital gains distributions.

Consider Types of Tax-deferred Accounts

There are many different types of investment accounts. For example:

Health Savings Accounts (HSAs)

Roth IRAs

IRA/401(k)/403(b)

Taxable investment accounts

If you have a high-deductible health care plan, HSAs are a must. They are triple-tax free. Money goes into the account tax-free. Your investment grows tax-free. Money used for qualified healthcare expenses can be withdrawn tax-free, too. Contrast this to a Roth IRA (you deposit after-tax money) or an IRA (you pay tax when you withdraw money).

Depending on your facts and circumstances, it can also be helpful to convert money from an IRA to a Roth IRA. Sometimes paying taxes now can be more beneficial than paying them later. Once you reach retirement, especially if you save diligently, your tax bill may be higher than you expect.

You want to be strategic about how you add money to or withdraw money from your tax-favored accounts. Planning to take money out of your tax-deferred accounts while you are in a lower tax bracket – even if you don’t plan to spend it – can be beneficial.

Delaying the start of your Social Security income can have benefits beyond increasing how much you receive. It can also help you create a low-income year or years. Use that period to lower your overall tax rate. Taking money out of your retirement accounts in low-tax years can reduce the total taxes paid during your lifetime.

Consider Asset Location

Real estate investors often emphasize the concept of “location, location, location.” Although many overlook it, location matters to investors, too.

In short, asset location refers to what type of account holds each investment. Investments can be held in tax-deferred accounts (e.g., IRAs), taxable accounts, or tax-exempt accounts (e.g., Roth IRA). Paying attention to asset location can improve your investment returns by reducing your tax bill.

If an investor has more than one type of investment account, she should consider which type of asset goes into which type of account. For example, interest income is taxed currently. High-yield bonds and bond funds may be better suited for your IRA. On the other hand, stocks can generate long-term capital gains. If you do not trade frequently, such assets may be better suited for your taxable account.

Concluding Thoughts

We hope the above gives you some idea of the benefits you’ll receive if you pay attention to taxes throughout the year. Don’t treat taxes as a necessary evil you have to deal with at the start of each year. Proper tax planning can help lower your tax bill and increase your portfolio’s value.

For investors, taxes take on even greater importance. Taxes and investing are essentially joined at the hip. Paying lower taxes on your investments should add to your portfolio’s value.

If you want to lower your tax bill, consider some of the following suggestions.

Pay Lower Taxes with Charitable Planning

Tax-loss Harvesting to Lower Your Bill

ETFs Rather Than Mutual Funds

Gains mutual funds realize from selling securities are distributed to the fund holders. Plus, mutual funds must sell underlying securities to free up cash for redemptions.

Consider Types of Tax-deferred Accounts

There are many different types of investment accounts. For example:

Health Savings Accounts (HSAs)

Roth IRAs

IRA/401(k)/403(b)

Taxable investment accounts

Consider Asset Location

Real estate investors often emphasize the concept of “location, location, location.” Although many overlook it, location matters to investors, too.

Concluding Thoughts

Disclosures: Zoe Financial, Inc. ("Zoe Financial") is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Zoe Financial provides investment advisory services and access to independent registered investment advisers through its platform. The information provided by Zoe Financial is for educational and informational purposes only and should not be construed as personalized investment advice or as an offer to buy or sell any security. All investments involve risk, including possible loss of principal. Past performance is not indicative of future results. Clients should consult with their own financial, tax, or legal professionals before making any investment decisions. The material presented by Zoe Financial is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Material presented has been gathered from sources believed to be reliable, however Adviser cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Past performance is no guarantee of future results. Zoe Financial does not provide legal or tax advice, and nothing contained in these materials should be taken as legal or tax advice. SEC Registration does not constitute an endorsement of Zoe Financial by the SEC nor does it indicate that Zoe Financial has attained a particular level of skill or ability. The sole purpose of this material is to inform, and it in no way is intended to be an offer or solicitation to purchase or sell any security, other investment or service, or to attract any funds or deposits. Investments mentioned may not be appropriate for all clients. Before making any investment, each investor should carefully consider the risks associated with the investment, as discussed in the applicable offering memorandum, and make a determination based upon their own particular circumstances, that the investment is consistent with their investment objectives and risk tolerance. Lower expenses do not guarantee better investment performance. Certain information contained herein may constitute forward-looking statements. Due to various risks and uncertainties, actual events, results or the performance of a fund may differ materially from those reflected or contemplated in such forward-looking statements.

Disclosure: This page is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accounting, tax, legal or financial advisors. The observations of industry trends should not be read as recommendations for stocks or sectors.

Investment advisory services are provided by Zoe Financial, Inc. (Zoe Financial), an investment adviser registered with the U.S. Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training. Learn more about Zoe Financial on the SEC’s Investment Adviser Public Disclosure website. Brokerage services are provided by Zoe Securities LLC and Apex Clearing Corporation, members of the Financial Industry Regulatory Authority Inc. (FINRA) and Securities Investor Protection Corporation (SIPC). Learn more about Zoe Securities and Apex on FINRA’s BrokerCheck website.

The information in the visuals above is for illustrative purposes only and does not represent an actual user's account, balance, or return. Zoe Financial does not provide tax or legal advice.

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