Are Higher Taxes On The Way? Having A Strategy Is Essential

By Reid Johnson

The current administration has already spent $1.9 trillion on COVID relief and has plans to spend trillions more on infrastructure projects, Medicaid expansion, education, and climate investments.

In order to fund these projects, the administration has proposed several tax-increasing measures on corporations and wealthy individuals. Under his plans, the corporate tax rate could increase from its current rate of 21% to 28%, and the long-term capital gains tax rate could rise from 20% to 39.6%. Marginal income tax rates and estate taxes are proposed to also go up. 

Considering all these uncertainties, it’s important to plan for the tax rates of the future. Preparing now for tax hikes is imperative because any one of them could significantly affect your tax burden – and down the road, your retirement. Rather than waiting to pay more in taxes in retirement, you may be able to take steps to help reduce your tax burden for the short term and long term. 

Convert traditional IRA to a Roth

Roth IRAs grow tax-free and distributions are not taxed as income when you withdraw money from them. Traditional IRA to Roth IRA conversions are taxable. But under today’s relatively low rates – especially compared with what the higher brackets might be if increases are implemented –  converting to a Roth might make sense depending on your income and benefits in retirement. Your CPA may not know how much you have in IRAs, so have a conversation with them and your financial adviser about the amount of money you have in qualified accounts, and see if a conversion is right for you. Remember, whatever is left in a Roth also passes tax-free to beneficiaries.

Take advantage of losses

Tax-loss harvesting is a strategy about minimizing capital gains taxes on your portfolio. If some of your investments did not do well, you sell those assets at a loss to offset gains and reduce your tax liability at the end of the year. Tax-loss harvesting can only be applied to taxable investment accounts. 

Leverage life insurance

An irrevocable life insurance trust (ILIT) is a vehicle that provides leverage. It allows you to take money out of your estate to reduce your tax burden in the future. With an ILIT, you put the life insurance inside the trust as a way to set aside funds to pay for future estate tax or other potential tax issues and not burden beneficiaries with this expense.

Speed up your lifetime gifting

The present tax laws provide a window of opportunity for managing inheritance and estate taxes. The Tax Cuts and Jobs Act of 2017 doubled the lifetime gift tax exemption to $11.18 million, thus providing a good opportunity to pass on a substantial part of wealth tax-free. But that increase will end after 2025, perhaps dropping to what it was before the TCJA – $5.6 million. If you’re a wealthy taxpayer, you should consider gifting whatever you have left of the current exemption. Identify what assets you would gift, who will receive them, and whether it makes sense to set up trusts for those recipients. 

Qualified Charitable Distributions (QCDs).

You can send money from your 401(k) or IRA directly to charities when you have your required minimum distribution. 

Defer deductions

If you think taxes will rise over the next several years, it may be wise to defer deductions until those higher tax rates kick in. For example, you could contribute less to charitable causes this year and contribute more during the higher tax years. 

More than ever, given all the uncertainty over future tax rates, strategizing to reduce your tax burden should be central to your financial planning. Taking control now might lessen future uncontrollables. 

Author Bio: Reid Johnson is president and founder of Texas-based Lake Point Advisory Group, LLC. He is an Investment Adviser Representative and holds life and health insurance licenses in Texas. As a financial professional and fiduciary when providing financial advice, he is dedicated to providing his clients with the individual attention necessary to help them pursue their financial goals. Johnson has contributed to various media sites, including Wall Street Select, CNN, and The Star-Telegram.