Ensuring you make the most of tax efficient strategies is an important but often overlooked core component of your financial planning.
"Income tax efficiency is an important component of your long-term financial plan, as it may lead to improved cash flow over time," says Tamara Telesko, Director, Wealth Planning Strategies with TIAA. "Having an improved cash flow can mean having more dollars saved and available for your retirement years. As your life changes, consider whether your current tax strategy still works or whether adjustments would help manage your tax situation going forward."
Analyzing—and potentially updating—your financial plan to account for new tax law changes and your evolving finances may greatly help your financial position down the road. Whether you've already filed your taxes this year or are in the middle of tax preparation, here are three long-term tax strategies you should consider discussing with your financial and tax advisors:
- Reduce your taxable income while saving for retirement
- Review how different types of accounts impact your tax liability
- Take a fresh look at itemizing your deductions
1. Reduce your taxable income while saving for retirement
Some of the most common investing and saving decisions, such as contributing to a workplace retirement plan, may result in a reduction in your taxable income. That's true whether you're taking the standard deduction or itemizing deductions on your return.
"For most, making pretax contributions in tax-deferred workplace plans and IRAs can substantially increase the amount of retirement assets you accumulate," Telesko says. "That's because, for many people, you postpone paying federal and state (if applicable) tax on the initial contribution. And the interest, dividends and capital gains generated within the plan also accumulate on a tax-deferred basis."
Contributions to a traditional IRA may be deductible, depending on your income level and whether you or your spouse were eligible to contribute to a retirement plan at work. If you didn't qualify in previous years, it's still important to check every year. Your changing income tax situation may impact your eligibility.
While contributions to Roth IRAs, Roth 401(k)s and Roth 403(b)s do not reduce your taxable income, withdrawals in retirement are tax free. With the current lower individual income tax rates potentially expiring after 2025, you may find that your tax rate is lower now than it will be in the future—meaning that tax-free income from your Roth account will benefit you down the road.
Your advisor can help you decide on the best approach and then include it in your plan.