Simply Money: Tax filing isn’t tax planning

Question: A.G from Hamilton County: I hate the idea of paying more taxes than absolutely necessary. How can I make sure I’m not overpaying?

A: With 2020’s Tax Day approaching (July 15th), we’re assuming your question is referring mostly to the act of preparing and filing a tax return and making sure you get every deduction possible. However, we want to shift your focus to the long-term act of tax planning – because this is often where we see people make the biggest (and most costly) mistakes.

For instance, if you decide to leave your job and roll over your traditional 401(k) to a traditional IRA, it’s critical to tell your former company you want a direct transfer. If a check gets written to you instead, 20% is held to pay federal income tax. It’s then incumbent upon you to pay back that amount within 60 days. That can be tough if you don’t have extra cash just lying around. 

We also see retirees wait way too long to start taking Required Minimum Distributions (RMDs), thereby potentially triggering a gigantic tax bill. While you need to start taking these withdrawals from tax-deferred accounts at age 72 by law, that doesn’t mean you can’t start withdrawing sooner. If you’ve saved well and will have other retirement income sources, it can be prudent to systematically begin taking out money as early as age 59 ½. This will help lower the balance of those accounts, reducing the tax hit when RMDs eventually kick in. (Reminder: RMDs are waived for 2020).

Then there’s also the strategic process of income distribution. This entails properly sequencing withdrawals from accounts with differing tax treatments so you can maximize tax efficiency. Otherwise, if you just haphazardly pull money out in retirement, you’ll likely pay more in taxes than you have to.

Here’s The Simply Money Point: If you really want to save money on taxes, do a little forward thinking about your tax planning strategy. Working with a credentialed advisor, tax professional, and even an estate planning attorney can help.