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Tackling Tax Risk: Effective Tax Risk Management Strategies



When planning your financial future, understanding Effective Tax Risk Management is key. It's not just about saving and investing; it's about smartly managing your taxes too.


Starting early, saving diligently, and balancing your investment portfolio are the basics. But as your wealth grows, Effective Tax Risk Management becomes crucial. Traditionally, taxes are secondary to investing, but they should be considered equally important.


Effective Tax Risk Management means looking at taxes alongside investing. Investments grow your wealth, while smart tax planning helps you keep it. In retirement, managing tax risks is even more vital since you'll rely on your savings, not a salary.


Many investors practice some form of tax management, like tax loss harvesting or converting a 401(k) to a Roth IRA. However, a more comprehensive approach to Effective Tax Risk Management, including tax allocation and diversification, is essential for a robust retirement plan.


Updating Retirement Tax Assumptions

It used to be commonly assumed that because you aren’t making a salary and are living on investments, taxes in retirement will be lower than in your working years.


If you’ve been diligently saving in a 401(k) or other tax-advantaged vehicle, that might not be the case. Depending on what you have saved, required minimum distributions may be high enough to create a larger tax burden. You also may have other taxable income, and up to 85% of social security is actually taxable. For many people, retirement tax brackets may not be all that much lower than when you were working.


Planning your retirement strategy so that you understand what your income is, and how much of it will be taxed, is critical since that tax burden directly impacts what you have to spend and how long your money will last.


Minimizing Tax Risk Through Diversification

Tax risk takes into account how much you are taxed in retirement. Looking at income through an investing lens, investors often focus on downside risk and how much market risk may impact the level of income in retirement. They also often look at growth projections to see if levels of growth experienced in the past are likely to be sustainable in the future, or if different investments are needed. It’s all about asset allocation, and building a diversified portfolio that can weather ups and downs and generate a given level of income.

From a tax perspective, it’s about how much of a bite will taxes take out of income, and how can you plan for that? Just like diversifying your investments to create an income stream, diversifying your tax situation can help even out your tax bite. This means ensuring you have investments with different tax treatments, that offer specific tax advantages.


These could be tax-free accounts, where contributions are made with after-tax dollars, and as long as certain conditions are met, no further taxes are due. Roth accounts are an example of this type of account. Taxable account contributions are also made with after-tax dollars, but the income generated by these accounts is generally taxable. Tax-deferred accounts are made with pre-tax dollars, and distributions are taxed as ordinary income.


Setting up a strategy that places the right assets and investment strategies in the right tax treatment can minimize tax risk and help ensure a sustainable level of income.


Tax Legislation Risk and Planning

Tax laws change, and this poses a tax legislation risk. Effective Tax Risk Management involves staying ahead of potential tax increases and legislative changes. This requires a flexible and proactive approach in your retirement planning.


The Bottom Line

Taxes, especially in retirement, are a significant part of financial planning. Effective Tax Risk Management involves strategies to minimize taxes and ensure a stable financial future.


 

About The Author


Alchemist Wealth is led by the expertise of Andrew J. Tudor, CFP®, RICP®, CAP® and Fred Tudor III, AFC®, MBA. Alchemist Wealth serves clients as a fiduciary specializing in providing fee-only financial planning, investment management, and retirement planning services. With over 2 decades of combined experience in financial services, Fred and Andrew bring a wealth of knowledge and personalized solutions to meet your financial goals.


The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.


This content not reviewed by FINRA


Alchemist Wealth, LLC is registered as an Investment Adviser with the State of Ohio and only provides advisory services in states where registered or otherwise exempt from registration. All information provided herein is for educational and informational purposes only and should not be viewed as investment advice. Any links to third party information or data are believed to contain accurate information at the time of publishing.


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