Every Dollar Has a Job (and a Tax Rate)
If you could create a bucket of money where YOU control the taxation, how valuable is that? Wouldn’t you want to explore contributing to vehicles like this in addition to your traditional 401ks and IRAs? In this post, we will discuss diversifying the taxation on your investments in addition to diversifying your investment asset class, to help make your overall plan “tax smart”.
What will the tax rates be in the future? Higher or lower than they are today?
No one knows! That is why we should look beyond traditional tax-deferred retirement plans such as 401ks and IRAs and create buckets of money that can be potentially accessed tax-free, such as Roth IRAs, Back Door Roth IRAs, and cash value life insurance.
Let’s explore a few examples of different types of accounts and how they are taxed:
- Tax-Deferred Retirement Plans:
- When you have a tax-deferred retirement plan, the taxability of your future withdrawals is dependent upon the government at tax rates at that time, as your withdrawals are taxed as ordinary income.
- Taxable Brokerage Accounts:
- Taxable brokerage accounts are funded with money you have already paid taxes on. Each year, you must pay taxes on dividends or interest from these accounts, even if you are reinvesting all dividends and interest. Capital gains tax is owed when you sell an investment and realize a gain.
- Tax-Free Benefits of a Roth IRA1:
- Withdrawals from Roth IRAs are tax-free when certain conditions are met. This includes the money you put in (contributions) and any investment earnings. Plus, there is no mandatory minimum amount you must withdraw each year.
- Cash Value Life Insurance2:
- Cash value life insurance gives you potential tax benefits: the money inside grows without immediate taxes, and you can access both principal and earnings potentially tax-free in the future, as long as you follow certain rules. This can be a valuable strategy for people who are not eligible to contribute to a Roth IRA.
Asset Allocation, which is a method of diversification that positions assets among major investment categories, does not guarantee a profit or protection against a loss.
Conclusion:
Diversifying your investments across several types of asset classes and accounts may enhance your portfolio, helping you to control both risk and taxation. Strategically placing investments to minimize taxes can boost your after-tax earnings. Understanding how asset allocation can reduce risk and help you diversify, along with asset location to reduce taxes, can ensure that you are doing all you can to invest wisely.
If you would like to discuss this further and explore ways to use Asset Location as part of your overall wealth management plan, please reach out to us today.
Note: Beacon Wealth Partners does not give tax advice, and you should seek the guidance and advice of your CPA, accountant, or tax professional, in addition to your financial advisor.
1Contributions to a Roth IRA may generally be withdrawn tax-free at any time. Earnings may generally be withdrawn income tax-free if the individual has held amounts in a Roth IRA for at least 5 years and the withdrawal is made after age 59 ½. If the withdrawal is made before the 5-year period and age 59 ½, income taxes and an additional 10% federal income tax penalty may apply. Other exceptions may apply.
Backdoor Roth IRAs are complicated vehicles that would require discussion with your personal tax advisor regarding your specific situation before taking any action or investing.
27702 is the section of the IRS tax code that addresses tax treatment of life insurance policies. When a permanent life insurance policy is structured correctly not only will the death benefit be income tax free, but cash value accumulation can be used tax free as well.
Duly-registered and duly-licensed financial professionals of Beacon Wealth Partners offer securities through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA/SIPC (Equitable Financial Advisors in MI & TN); offer investment advisory products and services through Equitable Advisors, LLC, an SEC registered investment advisor; and offer annuity and insurance products through Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC in CA; Equitable Network Insurance Agency of Utah, LLC in UT; Equitable Network of Puerto Rico, Inc., in PR). Equitable Advisors and Equitable Network are affiliates and do not provide tax or legal advice or services. Beacon Wealth Partners is not owned or operated by Equitable Advisors or Equitable Network. PPG-6737534.1 (6/24) (Exp. 6/26)