Why You Should Prioritize a Lifetime View of Taxes
We’re writing this around April 15th. I have to admit, it’s not my favorite day of the year. (Maybe I should also admit that I’m a big fan of extensions, so maybe April 15th is more symbolic.)
Still, taxes are top of mind for many of us this month. It’s common for taxes to be the #1 item in your household budget, and let’s just say it’s not going to something we’re excited about.
As you review last year’s decisions and consider the rest of the current year, I strongly urge you to keep a longer view of tax planning in mind. Here’s why.
Don’t Chase the Max Deduction Year by Year
There’s a temptation to get tunnel-visioned about how low we can get our tax bill each year. Tax planning is not just a year-by-year discipline. Many of the tax-related decisions we make each year have cascading effects, best observed over multiple years if not your lifetime.
In fact, there are common tax pitfalls where households incur far greater tax bills in the future for the sake of playing tax Limbo this year. “How low can you go?” This is what we want to protect you from.
Tax Mistake Case Study: Deferred Compensation Plans
One specific example has always stuck with me. We began working with an executive who had been maxing out his deferred compensation plan every year on the advice of a mentor. At the time we met, he had around $3.5M diligently stowed away.
It was a testament to his financial discipline. He had prioritized his savings and enjoyed the tax benefit each year. The problem? All of that money was going to be taxed at one time upon his exit!
And exit he did–with:
- A full year of salary
- Stock options vesting
- A severance package
- And a sign-on bonus to a new role
Thanks to his deferred comp plan, his taxable income neared $10M, all taxed at the maximum rate.
This story is a powerful reminder to talk with your CPA and your advisor before making tax decisions. Our job is to take a longer view of tax planning than year to year, and in doing so, maximize the lifetime value of your income.
Tax the Seed, Not the Crop
Stories like this are why we often recommend that high-income families consider tools like Roth IRAs or Roth 401(k)s which incur tax now, but let your assets grow tax-free. There is some debate in this area, but here are a few of the core reasons:
- If you look at history, we have a comparatively lower tax rate than the last 100 years. Deferring your tax liability places your future tax bill in the hands of the government.
- Tools like a Roth 401(k) can be passed generationally, allowing for multiple lifetimes of tax-free growth. What a way to invest in our kids!
Every household is different, and so each strategy will be somewhat unique. In principle though, we tend to encourage our clients to pay taxes on the seed they plant instead of the crop they want to reap.
Here to Serve You During Tax Season
As always, our heart is to help you Envizion More for you and your family. Our team is here with perspective to help you make the best financial decisions for your vision–not just this year, but well into the future.
If you are our client, we welcome the opportunity to serve you with everything from documents to collaborating with your CPA. We are all-hands-on-deck in our commitment to you.
Take care–Wayne.