Tax Strategies for Women
By Jennifer Hipkiss CFP®, EA, MSFP for the NABBW
Women are poised to be the leaders in wealth management over the next decade, with an estimated 40% of women controlling assets over $600,000 in America1.
Unfortunately, taxation can erode growth of wealth and useable financial resources for your goals – what you earn net of taxes is your true wealth of useable money. Implementing tax strategies to preserve your money will help you grow your wealth, as well as, provide added security to your financial plan without additional risk.
Fortunately, there are strategies to help you minimize your tax liability and put your money to more efficient use for you. Here are a few relevant strategies:
Implement a Tax-Efficient Investment Strategy
Our tax code created different types of income and the taxation of each varies. Creating an investment portfolio that minimizes your tax is key. Generally, ordinary income is income that is taxed at the standard rate.
Ordinary income includes income from social security, a traditional retirement plan distribution and most interest income. Capital gain (or loss) is the difference between the price you paid to acquire an investment asset less the proceeds for which you receive from the sale. Capital gain tax is not due until you realize (sell) the investment. Therefore, there are opportunities to time the transaction to flow in your overall financial plan.
Capital gains rates are less than ordinary income tax rates. In 2019, capital gains rates are either 0%, 15% or 20% for most assets held for more than a year. An additional 3.8% tax on investment income may apply to high income earners. Compared to ordinary income tax rates of 10%, 12%, 22%, 24%, 35% or 37%, you can save significant money making sure your investment strategy is tax efficient.
The type of asset you hold, how you hold it and how long you hold it matters. For example, a stock held in a taxable account will realize gains when the stock is sold for a higher price than the purchase price. If the stock is held 12 months or less, it is taxed at the standard tax rate. If you hold the stock for more than 12 months, you realize gain at the more preferential capital gains rates. However, if a stock is held within a mutual fund, capital gains may be applied to you even if you have not sold the mutual fund. These are important considerations when you decide what to buy and what type of account for which to hold the investment.
Invest in Tax-Free, Tax-Deferred and Taxable Accounts
Tax deferred accounts include Traditional Individual Retirement Accounts (IRAs), employer retirement plans (like 401k or 403b) and annuities. Taxable withdrawals from these accounts are taxed at ordinary income tax rates.
Money eligible to be withdrawn tax free can come from Roth IRA accounts and Health Savings Accounts. Finally, taxable accounts are those that tax the transactions completed within the accounts during the tax year of the transaction.
For example, if you sell an investment asset inside your employer retirement account and purchase a new investment, you will not be taxed in the year of that transaction. Instead, the tax will be deferred until you make a withdrawal from that account.
On the other hand, if you sell an asset within a taxable account, you will realize the tax in the year of the transaction. The way you time and structure what and when you sell investments can have a significant impact on your after tax growth on your investment.
You can use each of these different types of accounts to maximize their value. If you place assets that have preferential capital gain rates in taxable accounts and investment assets that generate ordinary income in tax deferred accounts, you can position the investment to create the lowest possible tax for you.
Manage Your Taxable Income
Timing can be used in tax management strategies to help you minimize overall taxes to you. Using the above strategies of having a mix of tax deferred, tax free and taxable account money, provides different buckets of money for you to withdraw funds you need.
In tax planning, we need to project the balances of each of these accounts and make a plan of withdrawals based on your overall financial plan. By creating this projection, we can create a plan to withdraw money from your accounts to create the income you need but in a way that creates the least tax liability. Since each of these buckets of money is taxed at a different rate, we can withdraw from each bucket in an appropriate mix to keep your taxable rate minimized.
Another important factor to realize in retirement is that your taxable income affects taxes due on your Social Security benefits, the premium you pay for Medicare or on the Health Insurance Marketplace, and your overall tax rate. Therefore, employing a tax strategy trickles down to many factors that can save you money overall. The more money that you save can be applied to the areas most valued by you.
Sources: 1BMO Wealth, Institute 2017; Forbes. 2014
NABBW member Jennifer Hipkiss CFP®, EA, MSFP is the Founder, Wealth & Tax Advisor for Vidyavest, a company created to focus on education, empowerment and serving tax & financial advice. Her goal is to integrate tax strategies into planning to provide added financial security without additional risk. Jennifer can be reached at JHipkiss@Vidyavest.com or through her website: www.vidyavest.com.