The Long Term View: Lifetime Tax Rates
When it comes to planning, taking a long-term view is crucial, and we often see it missed by individuals and their advisors when looking at taxes. They focus on the annual tax rates and how much they need to pay or can save, overlooking the concept of lifetime tax rates. Understanding and planning for your lifetime tax rate can lead to more effective strategies and significant savings over the long term.
What is a Lifetime Tax Rate?
The lifetime tax rate is the average rate of tax you pay over your entire lifetime. Unlike the annual tax rate, which changes based on yearly income and tax laws, the lifetime tax rate offers a broader perspective. It considers the cumulative effect of taxes over your entire earning and retirement periods, encompassing income tax, capital gains tax, gift tax, and estate tax. It also generally considers your legacy strategies and how those should best be blended for the impact on you and your heirs.
Why Lifetime Tax Rate Matters
Long-Term Savings: Let’s be real, who wants to save a couple thousand today and give the government hundreds of thousands more over their lifetime? Effective management of your lifetime tax rate can lead to significant long-term savings, maximizing the wealth you can accumulate and pass on.
Comprehensive Financial Planning: Planning with your lifetime tax rate in mind allows for a more holistic approach to wealth management, retirement planning, and estate planning.
Strategies for Managing Lifetime Tax Rates
Entity Selection: The entity structure of your business(es) will have a major impact on your lifetime tax rate. Including not only how your income is taxed as you operate the business but also on how it is transferred to your heirs or how a sale of the assets is taxed.
Estate Planning: Proper estate planning ensures that your assets are transferred to your heirs in a tax-efficient manner, considering potential estate taxes.
Tax-Efficient Investments: Investing in tax-efficient vehicles can minimize the tax impact on your investment returns. These can be operating businesses whose short term losses can offset high income years yet grow substantially in value over time or investments in which the gains have preferential tax treatment.
Income Smoothing: This involves balancing your income over the years to remain in a lower tax bracket, thereby reducing your overall tax rate.
Tax-Deferred Savings: Utilizing tax-deferred savings accounts like 401(k)s and IRAs can help lower your current taxable income and manage taxes over the long term. However, depending on your overall strategy these may or may not be useful depending on the year in which you are contributing.
Regular Review and Adjustment: Tax laws and personal circumstances change. Regularly reviewing and adjusting your financial strategies can help maintain an optimal lifetime tax rate.
Taking a long-term view of your tax obligations by focusing on your lifetime tax rate is a key component of effective planning. It requires a shift from merely looking at annual tax rates to understanding the cumulative impact of taxes over your lifetime. By employing strategic planning and regularly reviewing your financial situation, you can optimize your lifetime tax rate, leading to substantial savings and a more secure financial future.
Remember, managing your lifetime tax rate is not a one-time exercise but a continuous process that evolves with your life stages and changes in tax legislation.
At Ascend, our business advisory guides you to make the most impactful decisions to meet your unique objectives. For expert guidance on managing your lifetime tax rate and balancing it with your operations, fill out our form.