Why you need tax planning
Did you know that the largest expense for the average American household is not their mortgage, rent, groceries, or loan repayments? The single expense item that makes the biggest dent in an American household’s budget is taxes. Wondering how that is possible? Let’s take a look at a simple example of a married couple with two children. If the couple each make $75,000 a year and make $30,000 in combined 401k contributions, their adjusted gross income is $120,000. Assuming this couple takes the standard deduction, their taxable income for 2022 is $94,100. Using the 2022 tax brackets, the federal tax liability before tax credits is equal to $11,936. If both children qualify for the child tax credit, their net tax liability would be $7,936. You may be thinking, “That doesn’t sound too bad.” But, that is just the federal income tax the couple owes. Social Security and Medicare taxes equal to 7.65% also apply to the $150,000 of wages, resulting in $11,475 of additional taxes. If this couple lives in the state of Pennsylvania, the $150,000 of wages are taxed at a 3.07% state tax rate. That means $4,605 of state income tax is owed for the year. If you add that all up, you get to $24,016 of taxes due on this couple’s income, which is equal to 20% of the couple’s net income of $120,000! Add on property taxes, sales taxes, and transfer taxes and you could be looking at well over 30% of your income being paid out in taxes.
When many families are looking to make cuts in their budgets, often the food, utilities, or housing items are the first areas explored for decreased spending. Why not look to cut spending in your largest budget item - taxes? With some strategic planning, you could reduce your tax burden by thousands of dollars a year. You can’t easily save thousands of dollars a year in groceries. In the example above, if the couple contributed to an HSA, rented out their home for a few days a year, strategically sold and reinvested securities, or accelerated their charitable giving, they could have decreased their tax owed by several thousands of dollars.
Let’s take the benefits of tax planning to another level. Each dollar of tax saved results in a guaranteed rate of return. With the volatility of the stock market right now, many people enjoy the idea of guaranteed returns. If you are in the 22% federal tax bracket and a 5% state tax bracket, your tax planning strategies could result in a guaranteed 27% rate of return with each tax dollar saved! That is a hard rate to beat on even a good year invested in the traditional stock market.
So now you are on board and you implement some strategies that save you $2,000 a year in taxes. Great! Now what do you do with that extra savings? If you take that $2,000 of annual savings and invest it each year for 30 years into an investment that earns 8% annually, you end up with an additional $244,692 of income available to use for retirement spending, charitable giving, leaving an inheritance, or a variety of other things that line up with your values. That is no insignificant amount of change.
Tax planning is much more than trying to take every deduction possible at tax time. Planning needs to take place well before the end of the calendar year. Many individuals, families, and businesses don’t have the time or education to invest in developing a tax plan, which means potentially hundreds of thousands, or even millions, of dollars are being left on the table over the course of a lifetime. Don’t be one of those people. Work with an expert tax advisor to get your tax plan in place so that you can use your money for what matters most to you.
