My experience is that most tax-preparing CPAs and EAs look backwards, at the previous year’s tax experience. It takes overt client requests to have them do forward tax planning. As such, the more advanced financial advisor with a good understanding of the US and their respective state’s tax code might be a better source of advice.
Here are things to consider during different decades of your life.
In your 40s
One key strategy is to Buy real estate, a home, a townhouse, whatever. If part of your compensation package is company stock, you can use your concentrated stock position as collateral for the rather huge down payment. Many lenders, in lieu of cash down payment will allow you to pledge liquidatable assets for that mortgage purchase.
A very seasoned mortgage lender who owns multiple homes confided to me that had she had it to do over again, she would have bought her rentals first. This gets you into the real estate markets while having renters pay the mortgage service.
There are many tax advantages to real estate, especially rentals.
Private equity, placed properly, will give you excellent returns but is illiquid. Private equity demands attending to cash calls, and the holding period might extend to years beyond projects, but again the returns might justify the long holding periods. But here’s the tax twist. Private equity reports taxes annually on a K-1. Depreciation and other tax advantages flow to you, the investor.
In your 50s
Continue to buy rental real estate with that income you are not spending. Continue buying private equity with that income you are not spending. Also, if you have the desire and time, start a one-off business put it in an entity like a Subchapter S corporation or an LLC.
In today’s world, if you are in fact earning more that you spend you will undoubtedly be using a company retirement plan. Even retiring in your mid 60s, there is a great temptation to delay taking money out of that tax-deferred advice until you are required to take those taxable distributions. In many, many cases the account grows to over $2 million which then demands distributions over $80,000 delaying the distributions!
How do you reduce this burden? One way is changing your contributions to a Roth 401k or IRA. Some will counsel you against this because you aren’t getting that IRA tax benefit. This is a legitimate objection if you are looking at current year taxes. But having higher taxable income in your 70s, dealing with Medi-Care Part B and D costs as well as potentially higher tax rates must be part of the discussion in your 50s.
Next, while this suggestion contradicts the previous one, every tax-payer is different. Defined Benefit or Cash Balance Plans allow you as an employer to defer a max amount of money from taxes. The amount you can defer is far in excess of 401ks. While every situation is in fact different and this ought to be part of the discussion.
Tax planning considerations in your 60’s and 70’s.
In your 60s continue with what you were doing in your 40s and 50s…
But also consider Home Equity Conversion Mortgages, or HECMs for tax and Medicare Planning. Once you hit 65, regardless of whether you are still working or not, you will participate in Medicare part A. Some will also participate in Medicare part B. “Income-Related Monthly Adjustment Amount,” better known by the acronym IRMAA, or “Irma.” is a tax on your Medicare. It is very progressive, meaning that if your income is high two years ago, your IRMAA contributions will be high.
IRMAA is based on your modified adjusted gross income. You can manage it by using a HECM. Since what you pull out of your home’s equity is technically a loan, it isn’t income.
In years where you anticipate your taxable income spiking, manage that income down by not taking IRA distributions or by deferring your Social Security. This can allow you to convert traditional IRA assets to Roth assets—and taking a taxable distribution. Analyze the situation though. HECMs come with some up-front costs that need to be considered before you create the instrument.
Strategically use Charitable Giving. The first thing to note here is that if you are not charitably minded, stop right there. However if you are there are several tools you can use to make large enough contributions to move the needle on tax deductions.
As I have repeatedly said, I am not a licensed tax professional. Take all of the above concepts with a grain of salt and review them with someone in that profession before you take any advice.
In your 70s
All of the previous term’s periods apply but my experience is that those with wealth in their 70s are more concerned with providing for heirs than working the tax angle.
Give money away using Donor Advised Funds. A Donor Advised Fund is a simple, inexpensive way to take highly appreciated assets and provide them to charity. Another way is to use Qualified Charitable Distributionsrom your IRA. In many cases today, this is a better approach than a Donor Advised fund because ordinary income taxes as so much higher than capital gains tax.
