Written by Jonathan Vance, CFP®, EA
Tax planning is a focal point for individuals and advisors alike. I’ve yet to sit down with a client (or a friend, for that matter) who tells me they’re interested in paying more in taxes and being as tax inefficient as possible with their financial decisions.
While many of us are familiar with the terms “tax planning” or “tax strategy”, it’s important to remember that a tax plan is only as good as the financial plan it’s built on.
Your current and future tax liabilities are influenced by a complex mix of financial and personal factors. In retirement planning, two relatively straightforward variables have a drastic impact on how you might approach planning ahead for taxes: Asset Allocation and Spending (Withdrawals/Distributions)
To see how asset allocation and spending play a vital role in forward-looking tax strategies, consider two $1,000,000 portfolios over a 20-year time horizon.
After 20 years, the account balances diverge significantly, to approximately:
A Note On The Different Balances: Risk tolerance and spending levels are highly personal. Either scenario above can be "correct" depending on a family’s unique goals and values. However, knowing which one you plan to be is a crucial point for tax planning.
A larger portfolio (like Portfolio A) often results in a higher-income environment in the future. We’re specifically discussing if Portfolio A’s balance is invested primarily in some blend of these two account types:
Since forward-looking tax planning aims to fit your lifetime income into the lowest possible marginal brackets, your projected balance and the "tax status" of your accounts play a massive role in which tax planning tactics are appropriate, and how “conservative” or “aggressive” you might want to be with those tactics.
In addition to the marginal tax brackets themselves, it’s also important to consider other real dollar differentials that might be caused from things like:
How do you plan for taxes when the future is so uncertain? I argue that it’s relatively simple: control the variables you can and apply a different “confidence level” to your current, short-term, and long-term strategies.
Here is an overview of the three-level tax planning approach I advocate for with my clients.
At its core, tax planning starts with making sure you’re withholding the right amount throughout the year. Why does this matter?
Neither one is ideal. Level one tax planning helps to prevent surprises, wisely allocate capital throughout the year, and reduce stress around the April filing deadline.
To do level one tax planning, you need to create a current year projection of your expected tax situation.
For clients nearing or in retirement, their annual tax projection is often a mix of things like:
With your current-year projection in hand, you can finally answer the main question: Am I paying enough as I go?
For retirees, the "how" is often a bit more complex than it was during their working years. Rather than a simple W-2 withholding, you’re now juggling a mix of withholdings from various income sources. Getting this rhythm right each year can turn a frustrating exercise into an annual non event.
There’s some individual preference here, too. Some folks prefer to only pay enough in tax throughout the year to hit their minimum required safe harbor amounts. Others may try to hit their tax liability right on the nose or even pay a little extra so they can expect a tax refund when they file.
To quote Warren Buffett, there’s a “range of reasonableness” here. Just make sure you’re at least in the range.
Level two is defined by tactical planning over a two to five year time horizon. At this stage, we project forward to take advantage of temporary shifts in your financial situation. This proactive approach allows us to exploit short term differentials in your expected tax brackets.
For those nearing or entering retirement, this phase of life can be especially active from a tax planning perspective. The period from about five years before retirement until the start of Required Minimum Distributions is often one of the most influential time periods for tax strategy.
During these years, it can be essential to build and regularly re-analyze a cohesive plan. There’s enough moving pieces here that I dedicated a separate blog post to financial planning from ages 55 to 75, and even expanded into some non-tax concepts.
The primary goal of a short term strategy is to “smooth out” your income across multiple years.
Imagine you are 60 years old in 2026 and this is your final year of earning income before you retire. If your salary is $150,000 and you retire on December 31, 2026, your tax landscape will shift dramatically on January 1, 2027.
Looking ahead to 2027, your income might be minimal unless you have a pension, large taxable investment accounts, or something else. In this scenario, our strategy would identify 2026 as a “high tax year” and 2027 as a “low tax year”.
As such, we may wish to focus on deferring as much income as possible in 2026 to realize it during the following year when your marginal tax rates are lower.
Regularly fine-tuning your short-term tax strategy can put hundreds, or even thousands, back in your pocket every year. Over a lifetime, those "small" savings can have a significant impact.
Note: I say hundreds or even thousands as a reference point, but the reality is that the potential range of outcomes is far wider. Strategic planning won't always trigger a change. If your review concludes that no action is needed, you haven't wasted your time; you’ve simply confirmed that you aren't missing out on hidden opportunities.
This stage is where tax planning becomes more nuanced, and potentially provides the most value. While the first level focuses on the present and the second level looks a few years ahead, level three expands your tax planning strategy across decades.
Planning at this level usually requires specialized financial planning software or detailed spreadsheets to account for many financial variables. There is a wide range of commercially available retail software for consumers as well as institutional platforms specifically designed for professional financial planning firms.
I will not get sidetracked debating which specific program is best because nearly any of them can be used effectively for a Level 3 Tax Plan. However, there is one critical caveat to keep in mind throughout this process.
The assumptions you input will drive the recommendations the software outputs. It is vital to understand these underlying variables and recognize that they may not pan out exactly as illustrated.
Long term tax optimization is a game of approximation rather than precision. Understanding the potential pros and cons of any tax strategy or any financial move is crucial to guide your informed decision making process.
A comprehensive lifetime projection incorporates a moving mosaic of variables including future spending needs, investment returns, inflation, and the specific timing of income sources like Social Security and Required Minimum Distributions. These projections offer deep insights into why you may wish to strategically shift assets away from certain accounts or investment vehicles over time.
When executed correctly, this big picture strategy can significantly reduce the effective tax rate on your life savings that may have otherwise been paid to the government. It is easy to see how capturing even small rate differentials on large account balances can add to tens of thousands of dollars or more over time.
Note on Tax Avoidance: While the concept of avoiding lifetime taxes may feel like you’re doing something wrong, using the legal rules of our tax system to pay the least amount possible is actually encouraged by the IRS. The key point here is only using strategies that are legal and compliant.
Despite the significant potential benefits, this level of advanced planning requires a clear disclaimer.
Congress frequently changes tax laws which means even the most thorough strategies might not perform exactly as expected. It is easy to become overconfident in potential savings that remain purely theoretical. The further out we project into the future, the higher the chance that our assumptions will require adjustments down the road.
Because of this, Level 3 tax planning carries both the highest risk and the highest potential reward.
However, just because things may change in the future does not mean that we should avoid planning ahead using what we know to be true today.
Just as there is a risk that our tax plan may not pay off as expected due to a tax law change that ends up more favorable to us, there is an equally large risk that tax laws change to make things even less favorable in the future. In the latter scenario, the new laws would actually amplify the tax savings brought on by our forward looking strategy.
Since financial landscapes often shift, I recommend revisiting your tax plan at least once per year. For my wealth management clients, I conduct a forward looking projection each spring and a finalization meeting each November or December. This rhythm provides enough detail to stay on track without the need for constant recalculation, though we can certainly be more active during years of significant change.
Given the varying levels of risk and reward, I advocate for a weighted approach to apply all three levels of tax planning thoughtfully:
Ultimately, my goal is to make sure clients understand the risks and potential rewards of each level and to feel confident in the path forward.
As mentioned at the beginning of this piece, even basic decisions around how your money is invested, how large your account balances are, and how you plan to spend/give your money throughout your life plays a sizable role in how we need to approach planning ahead for taxes.
And though I’d be the first to advocate for being a good steward of making your financial plan as tax-optimized as possible, it’s also important to be intentional about what you want your money to do.
Saving on taxes is important, but, if extra tax savings are preventing you from taking a trip you’ve always wanted, finally updating your kitchen, or buying that Corvette you’d had your eye on, it may be more worth it to forego some tax savings from time to time to use your money on why you saved it in the first place.
To me, being “tax-efficient” means minimizing taxes to the best of your ability within your life’s framework, not necessarily putting life aside for the purpose of maximum tax reduction.
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