Will the IRS increase your taxes at the worst possible time?

I’ve written for, spoken to, and educated thousands of people during my career. I’m thankful for these opportunities and often focus on tax planning within overall financial planning. Tax planning is substantially fact-based and the financial impact may be great. Many people, and advisors, focus solely on picking investments. Prudent selection of investments is obviously  important but the impact is not nearly as controllable as tax planning.

If you’ve ever heard the statement “While you were watching the mice scurrying around, the elephant left the room” then know the investment choices are typically the mice and tax planning is the elephant! Think about your biggest expenses every year and taxes will be at or near the top of your list.

Like ocean waves crashing ashore only to flow back into the sea, life is full of ebbs and flows; there are many happy times and sad times. One of the most challenging times would be when your spouse dies. If you’re fortunate, you will enjoy or have enjoyed decades of experiences with your spouse. However, at the worst possible time (loss of a spouse) the Internal Revenue Service may add to the misery with a large tax increase for the surviving spouse!

In a case study, used at a recent workshop, a married couple had gross income in retirement of $120,000 from social security, pension, and IRA. The federal tax rate on this level of income from these sources is 12%.

Now I want to ask you a question; If you are married, what are the chances either you or your spouse will die first?...One, two three…ding! Pretty good chances aren’t they! Like 100%.  This is important because the problem I’m outlining in this article is very likely to affect you or your spouse. Either way, some of your combined wealth may be needlessly wasted.

Back to the case study! So, the husband passed away first and the following year, the widow experienced a 83% jump in her tax rate! The widow had the same $120,000 gross income from the same three sources, yet her federal income tax rate went from 12% to 22%! This just became a problem.

This is also a problem that can be anticipated and mitigated through strategic tax planning. While this case study used a married couple as an example, tax-efficient planning can be implemented with single, already widowed or divorced individuals as well.  Specific results will vary.

At PCA, we are prudent, disciplined and process-oriented in our selection of investments. I do not mean to suggest we don’t pay attention to that piece of your planning because we certainly do. It has been my experience that effective tax planning is largely ignored by financial advisors, consumers and even accountants or CPAs.

Remember a dollar saved is better than a dollar earned. The IRS will tax your earnings but does not your tax dollars saved.