Key points:
“Defense wins championships” is a mantra shared by many coaches and sports enthusiasts. In the world of financial planning, if offense is analogous to generating strong, risk-adjusted returns on investments, tax savings might be the complementary element needed to win the game. After all, it's not what you make—it’s what you keep that matters.
A friend recently asked how work was going. I mentioned being busier than usual during tax season, and he was surprised: “Why? My financial advisor doesn’t deal with taxes.” At Luminvest Wealth Management, we do things differently. Why? Because tax planning plays a crucial role in comprehensive financial advice. We go far beyond touting the benefits of tax loss harvesting. Here are some key areas where tax awareness significantly enhances investment management:
Understanding Your Marginal Tax Rate
A fundamental starting point for tax planning is knowing your marginal tax rate. This determines whether it’s advantageous to shift income from the present to the future (e.g., deductible 401(k) contributions, tax-loss harvesting) or from the future to the present (e.g., Roth conversions, realizing capital gains). Your marginal tax rate also helps decide whether to use taxable or tax-exempt bonds in your portfolio. Understanding your current tax situation—paired with a bit of foresight into next year—can help us determine the optimal timing for actions like rebalancing your portfolio, charitable giving, and more.
Medicare Premium Surcharges (IRMAA)
For pre-retiree and retiree clients, we monitor Modified Adjusted Gross Income (MAGI) closely because of its impact on Medicare Part B and D Income-Related Monthly Adjustment Amounts (IRMAA). Going just $1 over a threshold can trigger a monthly surcharge of over $130 per spouse—more than $3,100 per year for a married couple. Smart tax planning—like harvesting a loss or deferring income—can help prevent crossing that line. In some cases, a $1,000 charitable gift can reduce income just enough to sidestep the surcharge, yielding triple the value in tax and premium savings (plus a charitable deduction).
The Impact of the Standard Deduction
Before the Tax Cuts and Jobs Act (TCJA) of 2017, about 32% of taxpayers itemized deductions. That number has dropped to around 10% post-TCJA, meaning most taxpayers no longer get a tax benefit from mortgage interest, charitable giving, and other itemized deductions. For example, older home loans with low rates and balances often yield little or no tax benefit under today’s higher standard deduction. However, someone considering a new mortgage should understand the effective after-tax rate—it might be lower than the stated rate if deductions apply. This insight can guide decisions around a down payment or whether to borrow at all versus investing those funds.
Smarter Charitable Giving
Because many clients no longer itemize, we help them maximize their giving using strategies like “bunching” donations or making Qualified Charitable Distributions (QCDs) from IRAs. Clients with appreciated investments may benefit from donating securities directly to a Donor-Advised Fund (DAF) or charity. This avoids capital gains taxes and may still result in a charitable deduction. Some deductions are subject to limitations, potentially resulting in carryforwards that expire after five years—another factor we help clients manage.
Fees and Deductibility
Since TCJA, investment advisor fees are no longer deductible at the federal level (though some states still allow it). This change underscores the importance of working with an advisor whose fee structure is transparent and competitive.
Planning for Side Income
Clients with consulting gigs, side hustles, or self-employment income (reported on Schedule C) often overlook tax-advantaged savings options. We can help them set up a retirement plan like a Solo 401(k), even if they already have one through a current or former employer, enabling larger tax-deductible or Roth contributions, depending on their goals.
Understanding Spending and Burn Rate
When onboarding a new client—even before making investment recommendations—we often review their tax return to understand their actual spending. Here's a simple formula we use: Total Income – Taxes – Savings = Spending. Knowing your burn rate is one of the most important inputs to a financial plan. It improves the accuracy of our recommendations around retirement timing, savings targets, and investment allocation.
Avoiding Tax Surprises, Penalties, and Errors
Reviewing tax returns can help us anticipate and manage these outcomes, and spot errors—which, while rare, can be costly. We also assist with calculating estimated tax payments and knowing how different income is reported on tax forms to help our clients avoid underpayment penalties. Some investments, such as actively managed funds and private equity investments, often generate additional, unpredictable taxable income and complexity. Where appropriate, we find ways to make the portfolio more tax-efficient, often done at the security level as well as at the asset class level. We employ location optimization, prioritizing certain assets classes for different account types (taxable, tax-deferred, and Roth) in nearly every portfolio we manage.
Specialized Planning for Trusts
Clients with irrevocable trusts—credit shelter trusts, special needs trusts, dynasty trusts, etc.—face a unique set of tax and accounting rules. For example, Charitable Remainder Trusts (CRTs) distribute income using a “WIFO” (Worst In, First Out) approach, meaning the highest-taxed income is distributed first. In contrast, Pooled Income Funds are taxed on an “AIAO” (All In, All Out) basis, distributing all income annually. These nuances can inform strategic decisions about charitable structures and beneficiary planning.
In Summary
These are just a few examples of how tax planning complements investment management. Reviewing a client’s tax return provides us with a fuller picture of their financial life—helping us offer more personalized, precise advice. At Luminvest Wealth Management, we don’t just manage portfolios—we build strategies to help clients keep more of what they earn. That’s how you win the long game.
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