Tax management is an important concept that many people overlook when planning their finances. In this article, we’ll explore what tax management is, why it’s important, and provide key strategies to implement effective tax management into your financial plan.
What is Tax Management?
Tax management refers to proactively organizing your finances and assets to minimize your tax liability. The goal is to legally reduce taxes owed by taking advantage of tax laws, deductions, credits, income sources with preferential tax treatment, and more.
As Greg Hammer, President of Hammer Financial Group explains, “The idea and concept around tax management is how do we continue to maximize our income with the specific efforts around minimizing your taxes.”
Key Reasons Tax Management Matters
There are several important reasons why tax management should be part of your overall financial strategy:
- Taxes Are Your Largest Expense in Retirement
For most people, taxes end up being the single largest expense in retirement, exceeding housing, healthcare, and other costs. By minimizing taxes, you keep more of your hard-earned money.
As Greg highlights, “For most of us taxes are the single largest expense in retirement.”
- Taxes Impact All Phases of Your Financial Life
Taxes exist in all stages – during your working years, retirement, and even after death when assets pass to your heirs. Tax management optimizes each phase.
In Greg’s words: “You do not age out of taxes – taxes are something that are going to exist in all phases.”
- More IRS Scrutiny
The IRS has added over 87,000 new agents who will be monitoring tax returns more closely. Proactive tax planning helps avoid issues or penalties if audited.
- Taxes Are Not Intuitive
As Greg explains, “there’s nothing in intuitive whatsoever about the IRS tax code.” Without proper tax planning guidance, it’s challenging for most people to find opportunities to reduce their tax burden.
Key Components of an Effective Tax Management Plan
Implementing strategic tax management requires a proactive approach across these key areas:
- Understand All Your Options
The first step is a deep analysis of your entire financial situation to surface every potential tax planning opportunity available. As Greg advises, “The first step is just kind of getting things in order and developing those blueprints.”
- Tax Management Expertise
While most financial advisors focus solely on investment performance, a dedicated tax management advisor thinks holistically about how to minimize your lifetime tax liability. Their specialized expertise uncovers tax savings other advisors may miss.
In Greg’s words: “In tax management it’s going to be oversight on tax focused decisions like you know how can we mitigate taxes.”
- Asset & Income Stream Positioning
Order and timing matter when tapping into your various income sources. As Greg explains, tax management expertise helps determine, “where and how and what assets should we use today, tomorrow, next month…how should our income be constructed?”
- Ongoing Adaptation & Optimization
Laws change, situations evolve – tax management requires continually evaluating your approach for additional opportunities to reduce taxes owed.
As Greg emphasizes, “In that Journey what are the things that we constantly need to be doing to make use of the current tax laws?”
The Bucket Plan Philosophy
One effective tax management framework is what Greg refers to as the “Bucket Plan” philosophy. This divides your assets and income streams into three tax-optimized buckets aligned to different time horizons:
Now Bucket – For current expense needs in the next 12 months
Soon Bucket – Income to fill the gap between your current fixed income and desired lifestyle spending over the next 5-10 years
Later Bucket – Growth-oriented assets focused on countering inflation long-term and legacy planning
With the Bucket Plan philosophy, each bucket of assets serves a purpose to allow for tax-efficient income generation. This approach manages sequence of return risk in retirement and strives to minimize your total lifetime tax burden.
Key Takeaways
Incorporating proactive tax management into your overall financial plan is critical, as taxes end up being most people’s single largest lifetime expense.
Yet few advisors have specialized expertise in ongoing tax mitigation strategies. Seeking guidance from a dedicated tax management professional uncovers opportunities to legally reduce your tax liability and keep more of your hard-earned money over your lifetime.