When people hear "holistic financial planning," what does that mean? Most people know about retirement planning, preparing a monthly budget, life insurance, and tax returns each year. But most people may not know about how they all work together, and equally important, how do you personally do each part well to positively impact the others? A person can have a great retirement plan and sufficient money in it, but lack of emergency savings could ultimately drain a retirement account when an unexpected health issue arises, or a car breaks down. No one intentionally puts themselves or their family in a tough situation financially. It usually comes down to lack of knowledge due to not being interested, not knowing options, or not knowing that this important information exists. The advantage of having a financial advisor is to put these parts together, to create a plan that prepares you for life’s challenges and to discuss the options that are best for you to reach your goals.
Another professional that I would recommend is a tax advisor or CPA. They play a significant part of financial planning called tax planning. Having your financial advisor and your CPA partner together can improve your tax situation. Your tax situation is affected by your investments and all the other variables that make up your holistic financial plan. Therefore, having a partnership between your CPA and your financial advisor considers your bigger financial goals and ultimately benefits you more.
There is information that you should be aware of to improve your tax, and overall, financial picture. This includes:
1) Knowing Your Tax Bracket:
Knowing your tax bracket for the year is a good place to start for tax planning. There are seven federal tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The tax bracket you are in depends on your taxable income, which is usually different than your annual salary. There is a calculation involved to determine this number which includes deductions, among other things. A common misconception regarding tax brackets is that your full taxable income is taxed at your tax bracket. Instead, the government divides your taxable income into portions and each portion is taxed at its related rate.
2) Tax Deductions versus Tax Credits:
The difference between tax deductions and tax credits could mean a significant difference in taxes you owe, or tax returns you receive. Tax deductions are items that subtract from your taxable income. Tax credits are even more advantageous. They reduce your tax bill dollar for dollar. The best way to understand the difference is to think about how taxes are calculated and the order it is done. First, your Adjusted Gross Income, or AGI, is calculated, then your deductions are subtracted from this. Next, the rest of the tax equation is completed using this number. Tax credits, on the other hand, are subtracted last, usually resulting in a bigger reduction from your tax bill.
3) Standard versus Itemized Deductions:
Regarding the difference between standard and itemized deductions, this is fairly straightforward and depends on the person and, often, their occupation. Standard deductions are a dollar amount that is set for each tax bracket and is adjusted each year for inflation. This amount is subtracted from your AGI as previously discussed. Itemized deductions consist of adding up each individual tax deduction for which you qualify. The trick is knowing which deductions you qualify for and keeping accurate and organized records of it to prove it. If these deductions are greater than the standard deduction you qualify for, then itemizing may be a better option for you. There are strategies available to make this an attractive option for some people, namely the self-employed.
As with most important decisions, knowing your options is paramount. Knowing useful tax deductions and credits falls into this category. There are lists available to reference but some of the commonly known ones are: adoption, capital losses, charitable contributions, child tax credits, credit for the elderly or disabled, home office expenses, mortgage interest, medical expenses, property taxes, residential energy tax credits, and saver's credit. Using a tax advisor or CPA is extremely helpful in compiling this information specific to your situation.
4) Knowing Strategies Specific to Your Situation:
The first strategy that can apply specifically to you is adjusting your W-4. The W-4 tells your employer how much tax to withhold from your paycheck. Depending on certain variables and previous tax bills, you may want to increase or reduce your withholding. This can be adjusted throughout the year. Contributing into a 401K, if it is offered to you, is another way to reduce your taxable income. For 2021, $19,500 is the limit for yearly contributions to these accounts and if you are 50 or older you can contribute up to $26,000. Contributing to an IRA can allow for tax deductions for certain eligible people. Six thousand dollars is the maximum amount for IRA accounts with $7,000 permissible to those 50 and older. Contributing to a Flexible Spending Account (FSA) or Health Savings Account (HSA) may also be beneficial for reducing taxable income depending on your unique situation.
As with most things in life, a successful holistic and comprehensive financial plan relies on multiple components working together well. A financial plan can be thought of as an orchestra or sports team. There are roles for each investment and financial aspect of your life, and they must all be coordinated to best serve your ultimate financial goals. Tax planning is one important part of your holistic financial plan. It is important to know specific things about it that benefit your taxes and what to do about it. Tax planning doesn't take place only during tax season. Items you and your financial advisor can be aware of during the entire year include tax loss harvesting and capital gains being passed down by investments to investors, namely mutual funds. Being cognizant of what you can do throughout the year to improve your tax situation will ultimately benefit you and your loved ones in the immediate future and potentially for generations to come. Please let us know how we at Majestic Financial can help you or someone you care about.
Written by Leon Bennett, Chief Operating Officer, Majestic Financial, Financial Consultant, RJFS
*Any opinions are those of Leon Bennett and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
Leon Bennett, CFP®
Part of the Majestic consultant trio, Leon also assists the marketing team and is an avid fan of the Talking Heads and the Chicago Bears.