by Bruce Helmer, President of Wealth Enhancement Group

Taxes can be a complex and overlooked element of a financial plan. Yet, tax planning is critical to long-term financial success. Obviously, your goal is to pay as little tax as possible. But just as you never want to invest without considering tax implications, never invest for tax reasons only. Tax reduction is one part of the potential total return that you must analyze.

Three File Cabinets

When exploring how investments may be treated for tax purposes I find it useful to think of a home office and individual filing cabinets:

The first filing cabinet is for taxable investments: Earning on these investments is fully taxed in the year earned.

The second filing cabinet is for tax-deferred investments: Taxes on these investments are not paid when earned but are deferred until withdrawn, such as with 401(k)s and IRAs.
The third filing cabinet is for tax-advantaged investments. This category includes deductions and credits that may reduce one’s tax obligation, and investments such as Roth IRAs for which no taxes are due upon distributions, as well as when earnings are accrued.

I think there are three lessons to be drawn from any close examination of tax policy and its impact on individuals.

One, the current tax system allows tax-reduction strategies. Often people who should be taking advantage of them are not. They overlook them, in part, because they rely too much on tax-deferred retirement plans. Most people, with more careful and detailed tax planning as part of an integrated financial plan, could reduce their tax burden now and in the future, including taxes on their estates.

Two, the current tax system is extremely complex and eats up a lot of what could be otherwise productive time for CPAs and other financial professionals – not to mention our elected representatives. Wouldn’t the world be a better place if that brilliance could be applied elsewhere?

Three, individuals who try to do their own financial planning cannot possibly keep up with all these details. I’ve reiterated this in everything I have written, every lecture I have given and every radio show I have done: People should not try to do this themselves. Seek the help and guidance of a qualified and trustworthy financial professional.