Don’t Let the Tax Tail Wag the Dog
Don’t Let the Tax Tail Wag the Dog
Many people want to keep their taxes as low as possible. Perfectly reasonable. In fact, that’s a crucial part of financial planning. Pay as little taxes as legally possible, because every dollar you can keep for yourself instead of handing over to the IRS is a dollar that can work for you. Over many years compounded, this can end up making a significant difference in your total wealth.
However, I sometimes see this concern being overcorrected, to the point that the drive to keep taxes as low as possible comes at the expense of growth and total return.
I’ll just ask a simple question. Person A offers you $100,000 but you’ll have to pay 40% in taxes, and Person B offers you $20,000 with no tax liability. Which offer are you taking? Seems obvious and it is, but for someone overly focused on reducing taxes as much as possible, they might only see a $40k tax liability vs free money with no tax liability.
But clearly, taking the offer from Person B gives you only $20,000, while the offer from Person A gives you $60,000, net of taxes. What could you do with that extra $40,000? Quite a bit. It’s irrelevant that it came with a higher tax bill. It nets more to you, and that’s ultimately what matters.
Of course, in the real world, people aren’t just randomly handing out money (at least not that I’m aware of). The above example might seem overly obvious, and it intentionally was, but this overall concept holds true in the financial planning world, especially when it comes to taxable investment accounts.
Since interest, dividends and capital gains are taxed each year in these accounts, tax efficiency becomes important. The tax liability on these accounts absolutely must be considered and thoughtfully planned out to avoid a big and unpleasant surprise come tax time. But not at the cost of total net return to you.
No one should want to make less money for the sole purpose of paying less in taxes. That is an over-correction, that is letting the tax tail wag the dog.
There are many ways to reduce your tax burden while still having growth potential in your portfolio: using tax efficient investments, dollar cost averaging, the use of individual stocks (see my article on this: https://www.everest-wealthadvisors.com/blog/case-building-individual-stock-portfolio-taxable-investment-account); but growth is going to come with taxes sooner or later.
The net return to you is what matters. Make sure to speak with your advisor about your overall tax and financial plan. Make sure you're reducing your tax liability where you can, but don’t sacrifice having growth either.
Need help with your tax and financial plan? Text or call our office, or shoot me an email.
Talk soon.
Ryan Page, CFP®, MBA®
Office & Text:720-826-1092
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.
