When it comes to your investments, it is important to pay close attention and work with your financial planner and tax advisor before making changes, such as selling or taking a withdrawal. If not, you could trigger unintended tax consequences. 

For example, let’s say that you want to take money from your retirement account, or you received a nice sum of money from an inheritance, and now intend to use that money on a big purchase. What are the tax consequences of using that money on a big purchase? If the standard deduction for taxes is withheld, there is a chance that the amount will not be enough once the withdrawal amount is added to your annual income. How will you cover that tax liability if you spent all the money on a large purchase (minus the taxes), and you owe much more in taxes than expected?  

When you work with a CERTIFIED FINANCIAL PLANNER™ professional, you will receive fiduciary advice which seeks to protect you and helps to preserve your investments mitigate unintended tax consequences so there are no unpleasant surprises at tax time. 

Manage Your Taxes

The money you keep after paying taxes is the money you use to pay your expenses and enjoy life, so it is important to maximize your post-tax income. And while you cannot control trends in the market, or what the government will do on future tax laws, you can place yourself in a better financial position by working with a trusted financial planner who can guide you through careful, tax-efficient investing. 

Tax-free Investments Are Helpful 

Next, let’s explore some tax-efficient investment channels. There are some options that are exempt from taxes, and others that provide better tax rates at the time of withdrawal from the account.  

• Tax-free Municipal Bonds:  Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply. Municipal bonds are issued by a local government to improve the local infrastructure. An investment in municipal bonds is an investment in your local government—an investment that is paid back to you through interest payments and is exempt from taxation. Municipal bonds are subject to availability and change in price. They are suject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subjec tto the alternative minimum tax.
• Roth IRA and Roth 401K: A Roth IRA is an account that you contribute to after taxes have been paid. Withdrawals from your Roth IRA account are tax-free once the account is over five years old and you are at least 59 ½ years in age. A Roth IRA is a great asset because it can supplement your income after retirement. For more information on Roth IRAs, be sure to read our article, “7 Types of IRA’s and Which is Best for You”.

• A Roth 401K account is nearly identical to a Roth IRA account except that a Roth 401K account is offered through an employer. Sometimes an employer may offer matching funds to your contributions, and sometimes you are the sole contributor. Like a Roth IRA account, and unlike a typical 401K, withdrawals from a Roth 401K account are tax-free if you are over 59 ½ years old and the account is over five years old.  Withdrawals of earnings prior to age 59 1/2 or prior to the account being opened for 5 years, whichever is later, may result in 10% IRS penalty tax. Limitations and restrictions may apply. 

• 529 Plan: Higher education continues to grow more expensive almost annually. A 529 plan is a great way to financially support the education of your children and other beneficiaries. Not only can the money invested in a 529 account be used for a variety of purposes—college expenses, student loan payments, and more—but the money is usually tax-exempt upon withdrawal, provided the money is used to pay for qualified educational expenses. Beneficiaries can be of any age if they have a Social Security number. 
• Life Insurance Proceeds: While it can be difficult to think about what life will look like after you pass away, it is crucial to consider ways to care for your family financially after your death. Investing in a life insurance policy can be an efficient investment choice because the money your beneficiaries inherit from your life insurance policy is exempt from taxes. 

Investing in any or all of these channels can generate tax-free or tax-reduced interest not only for your future needs but for those individuals you leave your investments to later. Consider speaking with a CFP® professional to discuss, plan, and review your investments and plan for tax-efficient ways to preserve your funds.  

Spread Out Your Investments and Withdrawals 

When withdrawing money from a 401K or business retirement account, that withdrawal amount is set at a 20% withholding rate. The withdrawal amount will be added to your income at tax time. If you spend all of the withdrawal money on a very large purchase like a yacht or a house, you might find yourself unable to pay the tax bill. 

Planning ahead with your financial advisor allows you to schedule the most efficient way to perform large transactions. Elijah Heath, a CFP® professional at Heath Wealth Advisors, explains how a client wanted to pay off a $50,000 credit card balance. Instead of withdrawing that entire amount at once, Elijah recommended the client only withdraw a portion of the balance before the end of the year, then waited until January 1^st to withdraw the rest of the money that was needed. The withdrawals were spread out over two years to manage tax consequences based on his income bracket.

Diversifying your investment contributions is another way to better position your income and savings. If you are torn between wanting to invest in a normal IRA or 401K and a Roth account, split your investment between both types of accounts. A diverse set of tax brackets for your investments can help you avoid surprise changes in tax policies or market turbulence. 

Always Consult Professionals

Working with financial and tax professionals is the best way to create and organize a plan to manage your tax consequences.

Example: You owe $350,000 on your home and are considering withdrawing funds to pay it off. A withdrawal of that size would likely change your tax income bracket, resulting in a large tax bill at the end of the year. Consulting a financial advisor, such as a CERTIFIED FINANCIAL PLANNER™ professional, can create a plan to spread out your withdrawals over several years with the goal to keep you in a lower tax bracket, for example, or look at other losses you may have in your portfolio that can balance out a larger withdrawal amount. A tax and financial professional working together will aim to ensure you are making appropriate choices for your financial situation.  

Another option to consider when spreading out larger payments over several years is to consider a temporary loan. A margin loan, which lets you borrow against the value of your owned securities, can be used to offset the tax burden. Similarly, borrowing with an equity line against the value of your home may be a helpful tool in stretching out tax burdens with repayment plans over several years. 

Tax laws are ever-changing so it is important to check with your advisors to see if changes have occurred that may change your overall strategy.

We’re Here to Help You 

Elijah Heath, a CERTIFIED FINANCIAL PLANNER™ professional, is a *fiduciary with an ethical obligation to provide information, products, and services in your best interest, not what earns him the best fee or commission. Heath Wealth Management wants to be your advisor for life so you, your children, and your grandchildren all benefit from the relationship.

Call us to learn more, ask questions about your specific circumstances, and determine if we are the right fit for you. Our phone number is 813-556-7171. We can also be reached by email at Elijah.Heath@LPL.com.

Heath Wealth Management and LPL Financial do not provide tax or legal advice or services.  This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

*Fiduciary services are for advisory relationships only.