Tax Alpha


No investment advisor can honestly tell you that they can use their expertise to make you an additional 10% return on your investments. However, I can honestly say that I can, in many instances, save you 10% of your investments through good tax planning to get taxes paid on qualified money at the lowest possible bracket. You don’t want to leave a tip to the IRS!

How, you ask? I’ve got a lot of strategies. Taken altogether, they form what we’re calling “Tax Alpha”.

It’s pretty complex, so let’s put some building blocks in place first.

  • Tax-deferred “qualified retirement money” is going to be taxed when you take it out.
  • Social security is untaxed if you’re only living on social security and a small amount of additional income. But if you have more than a minor amount of retirement income, from IRA distributions, for example, it makes social security start to be taxable. During that time when your social security is phasing in as taxable you’re paying at either a 27.75% bracket (if you were otherwise in the 15% bracket) or at 46.25% marginal bracket (for those who thought they were in the 25% bracket.) It can also cause dividends and long-term capital gains to go from 0% to 15% taxed: it’s a bitter thing that sneaks up on people taking IRA distributions!
  • If you make over $85,000 single or $170,000 married filing joint, there’s an extra surcharge on your medicare premiums that works as a de facto extra tax. This number is not indexed for inflation, and after you lose your spouse you drop down to the “single” level. This is called the IRMAA threshold and it sounds like a good idea (“tax the rich”) until you realize it hits people who are merely taking distributions from their retirement plans for large purchases (like buying the RV they were saving up for, or paying for a nursing home.) There are several tiers of penalties and they’re going up in 2018 based on the 2016 tax returns. We can still help 2019 with the 2017 tax return, though!
  • Social security has to be repaid if you made over a certain threshold before your “full retirement age”, which makes the double taxation particularly painful.
  • Required Minimum Distributions (RMDs, sometimes called MRDs) are the government’s way of saying “we’ll let you defer taxes, but not forever. At some point you have to start paying them. They typically start after you’re on social security and that’s when you discover you’re in the highest tax bracket of your life. (Not what you meant to do when you deferred the taxes, was it?!?)
  • Tax rate on long-term gains and qualified dividends is currently at 0% if you’re in low brackets and 10% better than other ordinary income tax rates for higher earners. That means sometimes we can sell a stock to harvest the gain at 0%! (Massachusetts doesn’t buy into the nonsense of giving trust fund babies a 0% tax rate: you’ll pay the same rate on that investment income as you do on wages because of a robust constitution keeping the rich from tinkering with it.)
  • People talk about simplifying taxes as if it were all about changing the tax rates. It really isn’t! Taxes are complex because you have so many ways to earn income, and so many ways to show deductions, and so many credits (that phase-out at different income levels.) The actual tax calculation is easy-peasy. It’s determining what your taxable income is that is subject to so much manipulation, and determining what credits you can get that is subject to so much strategizing.

So a tax-focused comprehensive planner (that’s me) takes into account tax ramifications when providing investment advise. We will look at several things at the same time:

  • how much cash you need to fund your goals
  • what tax bracket are you likely to be in after age 71
  • how much room you have in the same or lower tax brackets now
  • all while paying attention to the IRMAA threshold
  • what credits can you qualify for at various income levels

I have a truly scary Excel spreadsheet to help solve these problems! I also use various tax planning tools. But without getting into numbers, here are some examples.

Fran and Alex are early retirees. They need $60,000/yr to fund their early retirement goals. They get talked into choosing the social security strategy that pays them the highest amount over their joint life expectancy. (That’s a whole ‘nother topic!) They still need money to live on, though. Let’s say they have $100,000 in after-tax money (plain old savings or investment accounts, not inside a retirement plan) and $900,000 in qualified retirement money.

In this case I’d run some calculations to see what bracket they’ll be in when they’re 71, and I’d convert as much as possible of the Trad. IRA into Roth IRAs each year (preferably using a clever Roth Conversion Strategy) and have them live on the taxable money for a while. This makes it so they’ll have more in their Roth IRAs and less in the taxable accounts as they go into old age. This protects the money from ever being taxed again, and provides some limited protection from creditors. The downside is that it puts the money in the name of just one of the couple, so if there’s a medicaid planning issue you’d have to consider that first, as well as carefully consider how this affects their estate planning.

Here’s another case: Sage is still working, still accumulating, still growing assets. All of Sage’s money is in workplace plans. When Sage retires, quite possibly not until age 70, there’s going to be a massive RMD hitting at the same time as social security payments start. The trick here is to use some other strategies; QLACs, and donor advised funds, and using the Roth side of a 401(k).

Dale is early-career but has an inheritance. In Dale’s case we’d pay attention to tax-loss harvesting of taxable investments, getting as much tax-deferred as we can at high brackets, but use Roth contributions once they’re down to low brackets. We’d also pay a lot of attention to other tax thresholds surrounding children.

Everyone loves to save taxes. An investment advisor who is tax-focused and considers comprehensive financial planning goals will do the best job for you. I am a member of the Alliance of Comprehensive Planners and that’s how we work.