How Do Taxes Influence Responsible Financial Planning

Whether you are saving for retirement or experiencing a major life event, taxes have an impact on your financial journey. Paying taxes is inevitable, but you can maximize your potential deductions and credits through several strategies.



With strategic tax planning, you can build your personal finances and keep more of your hard-earned money.

Key Takeaways

• Taxes influence every aspect of financial planning.
• Taxes have an impact on your budgeting, investment, retirement planning, estate planning, and debt management.
• Effective tax planning maximizes deductions and credits.
• Considering tax implications helps in retirement savings and investments.

Basics of Tax and Financial Planning

Want to manage your finances better? Start by learning the components of the tax system and the basics of financial planning. Here’s a quick overview:

Components of the Tax System

Income tax

This is a major component where individuals and businesses pay taxes on their earnings. When we think of income tax, wages and salary are the first things that come to mind. Income tax also includes dividends, investments, and business profits.

In the US, the Internal Revenue Service (IRS) collects taxes that you owe each year. The federal income tax rate ranges from 10% to 37%.



Income tax affects how much money you take home. The more you earn, the more income taxes you pay. When you know your net income after taxes, it’s easier to:

• Set a realistic budget
• Prioritize debt repayment
• Achieve your savings goals
• Ensure a balanced financial plan

Tax Brackets

Depending on your salary, you fall into different tax brackets, each with different tax rates.

For instance, lower incomes fall into tax brackets with relatively low tax rates. And adversely, higher earnings often mean a higher tax bracket. The first $10,000 might be taxed at 10%, the next $30,000 at 12%, and so on.

Tax Brackets (2024 for Single Filers)

• 10% on income up to $11,000
• 12% on income from $11,001 to $44,725
• 22% on income from $44,726 to $95,375
• 24% on income from $95,376 to $182,100

Let's consider how tax brackets impact financial planning using a real-life example. Imagine you have a gross salary of $50,000. For 2023, the standard deduction was $13,850 for single taxpayers.

Then, subtract the standard deduction from your gross salary. You now have a taxable income of $36,150. Now, let's proceed to the tax computation:

• The first $11,000 is taxed at 10%: $11,000 × 0.10 = $1,100.00
• The remaining $25,150 is taxed at 12%: $25,150 x 12% = $3,018
• Add them to get your total tax: $1,100 + $3,018 = $4,118



Some states have no income tax, while others have a flat rate structure. For example, Pennsylvania has a flat individual income tax rate of 3.07%. This means every resident pays the same rate regardless of their income level.

Tax Credits

When you file your tax return, you can claim tax credits and deductions that can lower your overall tax burden.

Tax credits can either directly lower your tax payment or increase your refund. For example, you can get a tax credit for installing solar panels in your home. Other tax credits you might qualify for include:

• Earned Income Tax Credit (EITC): For low to moderate-income workers.
• Adoption Credit: For qualified adoption expenses.
• Saver’s Credit: For taxpayers who put money into retirement savings.



Electric Vehicle (EV) Tax Credit: For people who purchase an electric or hybrid vehicle.

Tax Deductions

On the other hand, a tax deduction lowers your taxable income. Taxpayers like you may either take the standard deduction or itemize your deduction.

The standard deduction is a set amount that's not subject to tax. But if you have expenses like mortgage interest or medical bills, itemizing might be the way to go.

Imagine you paid a lot in mortgage interest and made several charitable donations—itemizing could end up saving you more than the standard deduction.

Both tax credits and deductions reduce your tax bill, but they work differently. For example, a $1,000 deduction lowers your taxable income by $1,000. But a $1,000 tax credit cuts your tax bill by $1,000 directly—pretty straightforward, right?



During tax season, make sure you get all the credits and deductions you qualify for. If you have qualified dependents, you may be eligible for certain credits and deductions.

Tax Compliance

As a taxpayer, it’s your responsibility to file and pay taxes on time. This includes submitting annual tax returns and paying any owed taxes by the deadline.



The date to remember is April 15 almost every year. Failure to comply can result in penalties and interest charges.

The Role of Taxes in Financial Planning

Financial planning helps you secure a financial future while managing present finances. Tax considerations are integral at every step of financial planning. Here’s how taxes play a role in each major step:

Budgeting: When you know how much tax you owe, it’s easier to create a realistic budget and allocate your after-tax income.

Investing: Planning for tax liabilities on investment returns helps ensure you won’t be caught off guard during tax season.

Retirement Planning: Tax-deferred and tax-free retirement accounts like Roth IRA influence your long-term tax liability and retirement income.

Estate Planning: Setting up wills and trusts helps minimize the tax burden on your estate.



Debt Management: Student loans or mortgages are tax-deductible, which can save you money come tax time.

Investment Strategies and Tax Implications

Understanding how taxes affect your investments is your guide to making smart, informed decisions. This section will discuss how to maximize capital gains tax and keep more money in your pocket.

Tax-Efficient Investing

Tax-efficient investing is all about minimizing your tax liabilities. One way to do this is by holding investments long-term. Long-term capital gains tax rates are usually lower than short-term rates.

By timing your investments wisely, your money can grow more without being heavily taxed.

Let’s say you own some stocks in your portfolio. If you hold stocks for over a year, you’ll pay a lower tax rate compared to selling them.



Another strategy is investing in municipal bonds. The interest earned in this investment vehicle is often tax-free at the federal level. This reduces your taxable income and keeps more money in your pocket.

Tax-Advantaged Retirement Accounts

Choosing the right retirement account is key to managing your tax situation both now and later. There are two main types of retirement accounts: tax-deferred and tax-free.

Traditional IRAs and 401(k)s are categorized as tax-deferred accounts. These allow you to contribute pre-tax dollars, which reduces your taxable income for that year. You'll pay taxes on these funds when you withdraw them in retirement.

On the other hand, tax-free accounts like Roth IRAs use after-tax dollars for contributions. While you don't get an immediate tax break, your withdrawals during retirement are tax-free.



You can take advantage of this if you expect to be in a higher tax bracket when you retire. Diversifying your retirement savings between these account types can give you more flexibility to manage your taxes efficiently in the future.

Tax Liabilities and Considerations Per Investment Types

Different investments come with their own tax implications. Stocks, bonds, mutual funds, and real estate are all taxed differently.

• Stocks may incur capital gains taxes when sold.
• Bonds typically provide interest income, which could be taxable.
• Mutual funds pass on tax liabilities to shareholders, making the fund's management choices important.
• Real estate investments may allow for depreciation deductions, which reduces your taxable income even if the property value increases.

To lower your tax burden, consider tax-loss harvesting. This strategy involves selling losing investments to offset gains from other investments.



Be aware of tax laws affecting dividends, especially with high-dividend-paying stocks. Each investment type requires different strategies to manage taxes effectively.

Retirement Planning and Tax Benefits

Now, it’s time to talk about retirement planning. This involves having an idea of retirement account types and their tax benefits. Let’s discuss them to help you make better financial decisions:

Types of Retirement Accounts

401(k) Plans

These are employer-sponsored and often come with matching contributions. In layman’s terms, you contribute pre-tax income, which lowers your taxable income.



Another benefit of 401(k) plans is that your retirement savings grow tax-deferred. However, you'll pay taxes when you withdraw the money in retirement.

Traditional IRA

Similar to a 401(k), this account allows you to contribute pre-tax dollars. Your traditional IRA contributions may be tax-deductible. It means you can reduce your taxable income by the amount you contribute to this retirement account.

For example, if you earn $50,000 a year and contribute $6,000 to a Traditional IRA, your taxable income would be reduced to $44,000. This gives you an immediate tax benefit and lowers the federal income tax you owe for that year.

Your investments grow tax-deferred, meaning you don't pay taxes on the earnings each year. Instead, the investments in your traditional IRA can grow and compound more efficiently over time.



However, you will pay taxes on these contributions and any earnings when you withdraw the money during retirement.

Roth IRAs

Roth IRA contributions aren't taxed because the contributions are made with after-tax dollars. The key benefit of a Roth IRA is your earnings grow tax-free. If your contributions earn $100,000 in profits, the earnings still grow tax-free.



When you withdraw money during retirement, you do not owe any taxes on those withdrawals. As long as you’re at least 59½ years old, you can withdraw contributions or any earnings with no tax and penalty.

The Role of Taxes in Retirement Planning

Taxes significantly impact your retirement savings. Knowing how different accounts are taxed helps you make informed decisions.

Pre-tax accounts like 401(k) plans and Traditional IRAs reduce your taxable income now, which is helpful if you're currently in a high tax bracket. Post-tax accounts like Roth IRAs provide tax-free withdrawals in retirement.

Also, remember that some accounts have required minimum distributions (RMDs). Traditional IRAs and 401(k) plans require you to start taking withdrawals at age 73, which affects your taxes each year.



Effectively managing the timing of your contributions and withdrawals can maximize your savings and minimize your tax burden. We recommend this strategy—contribute to a Traditional IRA during high-income years and switch to a Roth IRA when your income is lower.

Navigating Life Events and Tax Planning

As humans, we all go through different phases and cycles of life, each with its unique challenges and opportunities. In every phase, finances play a big role in them. Here are some life events that can impact your tax situation, along with actions you can take to stay on top of your finances.

Marriage, Family, and Filing Status

When you get married, your tax filing status changes. You can choose between “Married Filing Jointly” or “Married Filing Separately.” Filing jointly often provides tax benefits such as:

• Higher income thresholds for tax brackets.
• Bigger standard deductions.
• Eligibility for various tax credits.

Similarly, becoming a parent also impacts your taxes. You may qualify for credits like the Child Tax Credit or Earned Income Tax Credit. If you have dependents, you can also benefit from tax-advantaged accounts like a Flexible Spending Account (FSA) or Dependent Care Benefits.



In some cases, having a consultation with a tax advisor helps optimize your tax filing status and take full advantage of available credits and deductions. Consulting a tax professional for various tax-related matters can provide personalized advice to optimize your tax situation.

Real Estate, Mortgage, and Property Tax

Home ownership brings various tax considerations. You can deduct mortgage interest and property taxes from your taxable income. This can save you a lot, especially early on when interest payments are higher.



If you sell your home, understanding capital gains tax is crucial. If you've lived in your home for at least two years within the last five years, you may exclude up to $250,000 ($500,000 if married filing jointly) of the gain from your taxable income. Strategies like these can reduce your overall taxable income.

Kickstart Your Financial Journey Today

f you’d like to integrate tax planning into your comprehensive financial plan, get in touch with Leonard Financial Solutions today. We will take the guesswork out of tax and financial planning.

From tax credits and deductions to different tax-efficient strategies, we’ll work closely with you to improve your overall financial plan. Our Moorestown financial planning team is ready to give you personalized guidance to minimize taxes during retirement.



By choosing Leonard Financial Solutions, you choose a reliable partner. Book an appointment today!