Ep. 158 – Tax Planning Versus Tax Preparation

Did you know that you can legally and ethically avoid paying unnecessary taxes by working with the tax code? With tax planning, you can avoid tax risk.

Tax preparation is about being reactive while tax planning is about being proactive all year round every single year. Tax planning years in advance when done correctly, can massively change how much you pay in taxes.

In this episode of the Secure Your Retirement podcast, we talk about the benefits of tax planning in the long term as opposed to tax preparation. Listen in to learn how to pay less tax on your income after retirement if you make the same as before or even more.

In this episode, find out:

●     The benefits of tax planning and being proactive in the tax calendar year.

●     The big difference between tax preparation and planning – being reactive vs. proactive.

●     Minimize tax on social security benefits by planning to get the money into a tax-free scenario.

●     Why do many people make the same amount of income in retirement and even more?

●     The importance of putting all your money in pre-tax retirement assets like the IRAs and 401ks.

●     The importance of Roth conversions as part of your long-term tax planning goal.

●     Plan for your surviving spouse to ensure they aren’t paying more taxes than they’re supposed to.

Tweetable Quotes:

●     “In retirement, taxes can change the situation drastically in your favor as well as cost you a lot of money.” – Radon Stancil

●     “Roth conversions are a big way to start thinking about this long-term tax planning goal.”– Murs Tariq


If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary video course, Four Steps to Secure Your Retirement!

To access the course, simply visit POMWealth.net/podcast.

Here’s the Full Transcript:

Radon:Welcome to the Secure Your Retirement Podcast. Murs and I today are tackling a topic that pretty much everybody is concerned about, and that is taxes and how much you have to pay and how that works. The real theme here is that we’re talking about tax preparation versus tax planning, and they are very, very different. A lot of people treat taxes as almost a complaint after the fact. So basically you go to H&R Block, maybe you do it yourself. You use some software program, you file your taxes, and then you just complain about how much you have to pay in taxes. That’s called tax preparation. I put all my numbers in, I submit it to the IRS. There’s a computation that says this is how much money you made. Here’s how much money you owe in taxes.  
 One of the things that we talk to folks about quite a bit is particularly in retirement, taxes can change the situation drastically in your favor, as well as cost you a lot of money. So what we are proponents of is doing tax planning. Tax planning makes us think about things a little bit different. So Murs, can you kind of help person think through, and we’ve got the theme here, but this idea of tax planning. Maybe how we work with folks and what our CPAs do versus this idea of tax preparation.  
Murs:Yeah. So let me start with tax preparation, because it’s probably pretty fresh in everyone’s mind. We’ve just gotten through tax season and you either did it one of two ways. You did it yourself, your taxes yourself through a TurboTax or whatever it is, or you worked with either a tax preparer or a CPA. Think about the process there. We start to approach April and you know that you got to file and pay your taxes and so somewhere in the first quarter of the year, you start the process of getting documents together. All those 1099s, those W2s and all that, and getting it over to whoever’s going to be doing your taxes. So that’s all being done the year after tax year, basically. So we’re doing things essentially in arrears at this point.  
 So there are certain strategies and certain things that need to be actually be implemented in the calendar year. So right now we are in 2022 and we’re filing for tax year 2021. We’ve already filed for 2021 and so the big thing here with tax preparation versus tax planning, at this point, when you’re just filing your taxes, all you’re doing is recording what’s already been done. You had some income, you’ve had some investment gains losses probably. You’ve got some dividends. You’ve got all these different things, but all you’re doing is really marking it down on the 1040, on the tax documents to prove to the IRS here’s what’s happened and here’s how I’m going to pay the taxes.  
 There’s very little that we can do after the calendar year has flipped over to change our tax situation for in this case tax year 2021. So now it’s pretty much, let’s just get through all the paperwork, file the taxes and write the checks. There’s a couple things that we can do, and the most common thing that people can do after the tax year has completed is your IRA contributions or your Roth contributions. Your CPA may say, “Hey, it makes sense if you can put some money into your IRA and add a little bit more to your tax deduction for the previous tax year.” But that’s about it. There aren’t a whole lot of strategies that you can do after the calendar year has flipped over.  
 So that’s where tax planning comes into place. Now we’re being proactive about what’s going on throughout the year and different things that we can be looking at throughout the year. By the way, every single year is going to be different. You may have a high income earning year one year because you got some special bonus or something, and then you may have another year where it’s way off from that. Those are the years where we can start to think through hey, what could we be doing in this abnormal income year? So things start to come to mind like Roth conversions or charitable giving and all these different things. A lot of these have again, deadlines by 12/31.  
 So if we’re sitting here now coming up to the tax deadline of April of the year, well the 12/31 deadline is gone, and you probably can’t utilize that anymore. So that’s why we believe so much that tax planning and being proactive in the calendar year that we’re going to have to pay those taxes on, that’s where it makes a lot of sense. So thinking through it proactively rather than reactively and not just making it a chore of paying the taxes when that April comes around. Now we can start to think through hey, we’re now here in March, April, May of 2022. What can we be doing for the 2022 calendar year throughout the calendar year so that we can have a much smoother tax process when we start the file in 2023? If that makes sense.  
 So we’ve got a couple strategies that we’re going to walk you through, but the big difference is being reactive, which is essentially what tax preparing is and being proactive, what we believe is tax planning year round every single year and it’s different every single year.  
Radon:We’re going to talk about, like Murs said, a couple strategies that actually might be tax planning that’s years in advance. So not just a year in advance but years. The thing is, if we do this correctly, it can massively change how much you pay in taxes.  
 So let’s talk about one of the first things to consider, and that is minimizing tax on social security benefits. At this point you might go, whoa, whoa, whoa, what do you mean I got to pay taxes on social security? Well, if we make money, an income in retirement, and it’s not a tremendous amount of income, somewhere in the area of $40,000 for a married falling jointly per couple on their taxes, you would have to pay taxes on up to 85% of your social security benefits. So you think, well, how could I fix that problem? Well, the majority of people in retirement today, very few people have pensions. Most people have saved most of their savings in 401Ks and traditional IRAs.  
 The way that works is that if I have a million dollars in my IRA or 401k, I didn’t pay any tax on any of that, but when I pull it out, it is considered income. So if I’m going to supplement my social security benefits with say 20, $30,000 or $40,000 of taxable income from the IRA or 401k, that all now gets added in and that can increase the amount that I have to pay in taxes on my social security. So they well, how do I fix that problem? Well, we’re going to talk about it a little bit more detail on one of these strategies, but basically I can actually plan ahead and get the money out of a tax deferred scenario and get it into a tax free scenario, that it does not show up on my tax return as tax taxable income.  
 So now think about this. What if I had the ability to actually get the money out of the 401k, the traditional IRA and I did that over the course of say, 5, 6, 7 years prior to social security? Now I get to social security and social security is the only income I’ve got. Well, now I’m going to pay a very small tax burden every year on my income. Just a side benefit, this also could put us in a position where we pay the lowest premium for Medicare benefits. That’s not a tax, that’s a fee, but that could actually lower that. Maybe even have it so we have the smallest amount of fee on Medicare benefits, on Medicare insurance.  
 So it is huge to think about this ahead of time. This is not something that you can necessarily fix the year of. The year before turning 66.7, whatever your full social security age is. You can, it’s just a way more expensive way to do it. So plan ahead and if I’ve brought this up and you’re thinking, man, I got five years out to social security, seven years out to social security, this would be a scenario that you want to talk to us about. You want to make sure that you’re thinking, how do I plan ahead? How do I get myself into a position where I am going to pay the lowest tax rate possible? Now this leads into the kind of how we do that. So our next strategy, Murs.  
Murs:Yeah. So the next strategy essentially is kind of talking through what Radon just touched on, this idea of Roth conversions. Before I go into it, I want to set it up a little bit because… Well Radon, let me ask you this. We sit across the table with all types of different families, all types of age demographics and different backgrounds, different career pathways and all this. But how many times do we sit across the table with someone and they have this realization that they’re either going to be making the same amount of income in retirement as they were when they were working, or potentially even a higher income than what they were while they were earning? How often do we see that?  
Radon:We see it almost all the time. I would say 90 plus percent of the time and the reason why is because most of the people we sit with have been very good savers. Also, by the way, when they were working, they might have been making more money on their overall salary, but they were putting a ton of it ever into the 401k and other benefits so their bring home was much lower. So their bring home now in retirement is the same, if not more.  
Murs:The same, if not more. So go back and the old adage is put all of your money into these pretax retirement assets like your 401ks, your pretax traditional IRAs, 403(b)s. Put all the money in those because when you retire, for sure, it makes sense that very likely your income is going to be lower in retirement, and that would mean that you would be in a lower tax bracket. Well we’re seeing that old adage being broken every single day now with people making the same amount of money, if not higher. So their tax bracket is staying about the same, if not higher. So now in comes this idea of we’ve got so many clients, so many retirees with a lot of money in these pre-tax assets, and they’re starting to realize whoa, I’m going to have a lot of income that I don’t really need. I’m going to hit RMD age at 72 or the potential of it being 75. I read an article about that the other day. However-  
Radon:Just because we’re going fast here, since you brought it up, say what RMD stands for.  
Murs:Yeah. So RMDs is required minimum distributions. You’re required, the IRS says we’ve let you defer these taxes for so long, but at 72, current law is 72. You are going to be required to take out a portion of those funds every single year for the rest of your life. So take money out, pay the taxes on it, and then do whatever with the remaining of the funds. Basically the IRS wants their tax money. You’ve been deferring it for so long and so RMDs is another windfall that people start to realize, whoa, I’ve got all this money in 401k, IRA money. I’m going to approach this age of 72 and this RMD is going to wreck my tax scenario.  
 So Roth conversions are a big way to start thinking about this long term tax planning goal. So if you’re of the mindset of your tax rate is going to be the same, if not higher now in retirement and think about where we are from a tax rate perspective. We’re in one of the cheapest tax environments that we’ve been in a while. We already know in 2026, taxes are going to go up unless there is some significant legislation that goes through. So we already know that in a few years, it’s going up and then everyone out there saying they’re going to continue to go higher because of what’s going on with the economy because of where the national debt is, and the solution there is to raise taxes. We don’t know if that’s actually going to happen, but if you are of the mindset that that is a possibility, then you may want to start considering these Roth conversions.  
 Again, the concept is you elect to basically roll money from a pre-tax IRA or a Roth. I mean, pretax 401k, or IRA, pay the taxes and convert it into a tax-free bucket called the Roth. Now this isn’t fun to do in a given year. You’re electing to pay some taxes before you would normally have to. But the idea here is to get tax-free growth and to reduce your tax situation over the long run. So that’s where this five year, 10 year, 15 year planning starts to really come into play and this is where we can start to look for advantages in certain tax years.  
 Like Radon said, planning around social security to make that situation a little bit better. Or maybe you retire early at say 62, and you’ve got 10 years before you hit that RMD age of 72. You’ve got 10 years of a relatively lower tax environment where you may say hey, let’s come up with a plan to start converting a certain amount of my pre-tax assets into this Roth bucket so that when I hit 72, a couple things have happened. My pre-tax has gone down, which means my RMDs have gone down. Now I’ve got this tax free bucket that is growing tax free, and also I can utilize it to kind of… I’ve got money in different buckets that I can now be very flexible in my tax situation.  
 So Roth conversions are a big conversation that we’re having right now with everyone. We think they make a lot of sense. It doesn’t make sense for everyone, but having the conversation makes a ton of sense. So if you’re not speaking with your advisor about it, make sure to bring it up. We’re happy to have the conversation with you as well. So that’s one big strategy that you don’t want to forget about.  
Radon:All right. Our next strategy is something to think about. I know that it’s not fun to think about, but it is planning for your surviving spouse. Why would we want to talk about that? Well, again, if we think about the fact that if one person were to pass away and leave a single person, then no longer can they file married jointly. Now that person has to file a single and what that does is it makes the amount of income that you can make at certain brackets go lower, which means that the person could go into a higher tax bracket as being a single person. It also reduces how much you get as a standard deduction. So that is also an effect.  
 It all comes back to this idea that if we can get money into a place where we don’t have to pay taxes on it in the future, even if we say, well, look, we’re going to do a hybrid plan. We can’t do it all. We’re going to start. Maybe we’re running a little bit late on this, but we’re going to start and we’re going to set up accounts that will be tax friendly for the surviving spouse that could just help alter this idea that all of a sudden this income… Because if we’ve got this income coming in and it’s all taxable, and then all of a sudden one person passes away and leaves a single person, all of a sudden they’re going to be paying more taxes. So we basically just transferred money to the IRS versus being able to transfer that to our family.  
 So I’m not going to talk about that a lot. I just want to set the seed that planning ahead, even if we’re already passed social security age and we’re sitting here, we can still do planning. If we look futuristically around this idea of taxes we can actually help in future tax brackets. So keep that in mind. I want the big theme here to be tax planning versus tax preparation. We can avoid tax risk with a plan. That’s the ultimate of this goal is to avoid having to pay taxes that we don’t have to. Legally and ethically we can get out of having to pay those taxes if we just work with the tax code.  
 We hope this has been beneficial. We hope it’s been helpful. We have an entire article written on this. If you go to our website, which is POMwealth.net, go to the blog page, we’ve got an article written right on this topic. That way you’ve got all the information right in front of you.  
 If you are listening to this and you go, oh my goodness, I’d love to be able to sit down or have a phone conversation with you, feel free to on the website top right hand corner you can click on a button that says complimentary phone conversation. Murs and I would love to be able to have that conversation with you and see if we might be able to help. But for now, we’ll say thank you very much for listening. We’ll talk to you again next week.