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July 23, 2015

The IRS collects over one trillion dollars each year from individual income taxes. Most of us want to avoid paying more than our fair share in taxes. There are numerous ways to accomplish this goal.

Perhaps one of the most common decisions we are faced with is whether to contribute to a Roth or a Traditional retirement plan. If you elect to save into a Traditional 401(k) the amount you defer reduces your taxable income, plus your employer may match your contributions up to a certain amount. This is huge; the opportunity for tax deferral and free money. If you don’t have a 401(k) as an option, you may also be able to accomplish deductible contributions by funding a Traditional IRA. Distributions from Traditional 401(k) and IRAs are typically taxed as ordinary income and may be subject to early withdrawal penalties if withdrawn prior to reaching age 59 1/2. This means that when you reach your retirement age and you look at your Traditional account balance, a fair portion of that money is actually “owned” by the IRS. The Roth versions of these accounts do not provide the up front deductibility, instead they are funded with after tax contributions. Subject to certain IRS regulations withdrawals from Roth accounts are tax free. That means if you retire with $1 million in your Roth, and you have followed the IRS rules, all of that money is yours.

Recently the IRS has changed the rules around Roth Conversions, making this strategy worth considering in some situations. The basic concept is to convert your pre tax retirement savings held in a Traditional account to a Roth account. This triggers a taxable event, but depending on your specific situation, it may be advantageous in the long term.

If you are a business owner, self employed, or some combination of both, there are several tax planning strategies that may make sense. Defined Benefit plans are probably the most well known, but there are a vast amount of lesser known plans that can be customized to fit your specific goals and circumstances. The rules around setting up these plans are more complex and working with a fiduciary advisor is not a bad idea.

Navigating the contribution limits, age rules, and other changes to the laws that the IRS makes can be confusing at times. One of the most effective ways to navigate this process is to work with a professional who is versed in the various forms of strategic tax planning. That Advisor should dive deep into the Financial Planning process to uncover all possible combinations of tax strategies. With a complete Financial Plan and some creative planning recommendations the conversation can then be elevated to include your CPA. The collaboration of your Advisor and your CPA is a powerful team.

If you’re not sure whether this level of tax planning is right for you or not click here to learn more.