A lot can change in five years. It can be your career, your family situation, or financial priorities. Maybe you were single then but are married now and have kids, or perhaps your investment portfolio has grown significantly. If your life has changed but your tax strategy is the same, it may no longer be working in your favor.
This is a common mistake made by most people. Many people create a tax plan once, either with a CPA or by simply repeating what worked the previous year, and assume it will continue to meet their needs. People often think that you have to set up tax planning once and let it go on for years. Good tax planning should evolve as your family, assets, and financial goals change. Otherwise, you could miss valuable tax-saving opportunities or face unexpected tax bills.
The good news is that events in your daily life can signal when it’s time to revisit and rethink your tax plan. Let’s understand and review the steps you can take to make sure your strategy fits well for your financial situation.
Why Your Tax Plan Doesn’t Last Forever
A tax strategy is not a one-time thing, meaning once it is done, you don’t have to just forget it. It is based on your financial situation at a specific point in time: income, filing status, dependents, investments, and the types of accounts you own. Any minor or major changes to these details can make the existing strategy less effective. In some cases, you may not realize it’s outdated until you’re faced with a larger tax bill than expected.
Staying on top of those changes is your responsibility, as you should not rely on the IRS to notify you about every life change that may affect your tax situation. So it is a good idea to review your tax strategy whenever a major life or financial event occurs. Some of the common life changes are mentioned below.
1. Family and Household Changes
Some of the biggest tax consequences can result from major family milestones
- When you are focused on planning a wedding, going through divorce, or sending a child off to college, with so much on your plate, updating your tax strategy is usually not in your mind, or you do not consider it that important. Still, these life changes can significantly affect how much tax you owe or the deductions and credits you’re eligible to claim.
Getting married: Marriage is a major life event that can change your tax situation. Filing a joint tax return can change how your income is taxed. After marriage, the combined income may end up in a tax bracket that is different from where you were individually. You should review your paycheck withholding so you do not get an unexpected tax bill or refund when you file your return.
You should update your Form W-4 soon after your marital status changes, and the IRS also recommends reviewing your withholding after a change in marital status.
Going through a divorce or legal separation: Divorce can create major tax issues, and determining your filing status and tax responsibilities. Jointly owned assets like investment accounts, retirement savings, and others often have tax implications, and mistakes can be expensive. After your divorce is finalized, it is important to update your Form W-4 to reflect your new filing status. Your records with the Social Security Administration should be updated before filing your tax return if you change your last name. Even a minor mistake in name or a name mismatch can delay the processing of your refund.
Children Becoming Independent or Going to College: Your tax situation can change as your children grow older. If you’re using funds from a 529 college savings plan, the withdrawals should be used for education expenses that are covered under the plan. Using the funds incorrectly could result in taxes and penalties. You must consider the tax consequences of selling your home before listing it if you’re also thinking about downsizing now that your children have moved out. Planning can help you understand whether you’ll qualify for the home sale exclusion or face any unexpected capital gains taxes.
2. Career and Income Shifts
Everyone faces change in their career over time, and a major shift in income or employment is a good reason to update your tax strategy. Things like a promotion, a pay cut, a career change, or even a temporary break from work can all create new tax planning opportunities.
A higher income: If you have received a raise or moved into a higher-paying job, you may have moved into a higher tax bracket. It is usually a good idea to review your investment strategy, particularly how capital gains, dividends, and other taxable income fit into the picture. It will be easier for you to manage overall tax liability if you are one step ahead in tax planning.
A lower income: A low-income year can create great tax-saving opportunities.A Roth conversion is one strategy you may want to consider. Because you’ll owe income tax on the amount you convert, completing it during a lower-income year may result in a smaller tax bill than waiting until your earnings increase.
Starting a new job: A new employer often comes with a different benefits package, making it the perfect time to review your retirement savings strategy. If most of your retirement assets are in tax-deferred accounts, such as a traditional 401(k) or IRA, consider whether adding Roth savings would improve your long-term tax flexibility. If your employer offers a Roth 401(k), contributing to both traditional and Roth accounts can provide more options for managing taxes in retirement.
3. Getting Closer to Retirement
It is very important to manage taxes on your retirement income. It is not just about building your savings; it’s also about understanding how you’ll withdraw that money in the most tax-efficient way.
A retirement tax plan takes time to develop, so it can be helpful to start planning your retirement withdrawal strategy several years before you expect to retire. The order in which you take money from different accounts can have a significant impact on your tax bill over the years. For many retirees, that means planning around required minimum distributions (RMDs) when they apply, using income from taxable investment accounts, spending maturing bonds or certificates of deposit (CDs) as needed, and preserving Roth accounts for later. Because qualified Roth withdrawals are generally tax-free, leaving those funds invested for as long as possible can provide valuable tax benefits later in retirement.
People often do not think about when their regular paycheck ends; automatic tax withholding usually ends with it. You can choose to have taxes withheld from certain income sources, like IRA withdrawals, Social Security benefits, or annuity payments. However, taxes on investment gains generally are not automatically withheld when you sell investments at a profit. Most brokerage firms won’t automatically withhold taxes on capital gains, which means you could end up needing to make estimated quarterly tax payments to avoid an unexpected tax bill.
How Can Your Investments Change Your Tax Plan?
If your investments have begun generating more income for you, you might want to review your existing tax plan. For instance, you could have made a profit from shares, savings, or another source of investments. You might also make a profit when you sell an item for a price higher than the amount you paid for it. The resulting profit could increase your taxable income and, because of this, raise your tax liability.
Before selling a very profitable investment, determine how your tax position will be affected. Selling a big chunk all at once might result in a larger tax payment. Still, under certain circumstances, you can stagger your disposal of investments to distribute your tax liabilities. Apart from that, you have to think about your investments that have gone down in value. In some situations, such a capital loss may reduce the tax amount you need to pay. But there are certain limitations as to the extent the losses can be utilized.
Also, where you hold your money can affect how it is taxed. For instance, money deposited in a normal investment account is subject to a taxation regime different from that applied to retirement account funds or Roth accounts. As your circumstances and desires evolve, you might have to change your tax plan too.
Buying or Selling a Home
Another major financial change that may affect your tax plan is buying or selling a home. Buying or selling a house might also be a matter of taxes. For example, your new house can result in an increase or decrease in your mortgage interest and your property tax payment. When you sell a house, you might end up with a capital gain. If you have owned your house for a while, it is a very good idea to figure out the tax consequences before you take any steps so you can be prepared and so you can avoid unexpected tax consequences.
In case you move to another state, you will probably need to deal with additional aspects of state taxes. Your tax liabilities will depend mainly on your residence, your employment location, or the length of time you spend in different states. Major transitions like changing residence should be part of your tax planning list.
How Can an Annual Tax Planning Checklist Help?
It may be hard to believe, but your life event tax planning can actually take a completely different track in a span of one year. A few major milestones you may experience, like marriage, job change, childbirth, home purchase, launching a startup, or increasing your earnings, could definitely have a ripple effect on your annual taxes. For these reasons, you ought to consider updating your tax strategy every once in a while. You do not have to wait until year-end tax filing to review your tax plan. Starting your tax planning checklist earlier enables you to carry out the necessary updates and preparations with ample time on your hands.
The first point to look at is the state of your income. Has it taken a new direction or increased? Have you set up a company or initiated monetization of a new idea? Your next consideration is your immediate family. Have you gotten married, gone through a divorce, had a baby, or has a child who once depended on you become financially independent?
Also, a good idea is to revise your assets, like savings, investments, property, retirement, and charities. Any significant change in those would likely call for updating your tax strategy. Just a brief year-on-year review can be extremely beneficial because it would highlight the tax issues in time and allow for better management when you are getting your taxes done. Above all, your tax plan should reflect the current state of your life and not of when you can imagine that you were quite the opposite person just a few years prior.
When Should You Update Your Tax Strategy?
There is actually no fixed period of time that is right for everyone. For instance, when there is a big change in your family, job income, or finances, it is wise to take a look at your tax plan again. It is also a good idea to revise your planning and tax withholding at least six months before the tax year comes to an end instead of leaving the task until the time you file your taxes. You may save yourself from some unpleasant and stressful situations that arise in the final moments when trying to file the taxes.
In fact, the earlier the planning takes place, the more options there are to be able to change the plan. Possibly, one could modify the amount of retirement savings, decide when to sell an asset, verify tax withholding amounts, and even plan tax-deductible charitable donations before the end of the tax year.
The aim of a tax plan review goes beyond just trying to pay less tax. It is a matter of fitting your tax plan to the state of your life at present. Over time, your income, family, investment portfolio, and retirement intentions may all undergo changes, and you’ll probably have to revisit your tax plan with them.
Conclusion
As you progress through different stages in your life, your tax strategy should also adapt to and grow with it. Major changes like getting married, a divorce, having children, changing careers, income level fluctuations, making investments, buying a home, generating income from a business, or retiring are all things that can change your financial and tax situations significantly.A plan that worked well three years ago may no longer fit your current situation. Routine tax life event planning can help you to see which changes may have major impacts on your overall taxation so that you are in a position to make more informed and financially wise decisions.
Instead of waiting until tax season to discover that you owe more than expected, you should keep your tax plan up to date. When your situation changes, be sure to adjust your plan because of this. In addition, a tax expert can assist you in evaluating the tax aspects of significant life choices and developing a customized plan based on your financial goals at that moment in time.
FAQs
Question 1. How regularly should I change my tax plan?
In general, you should change your tax plan at least once a year. In addition, if you have any major changes in your family, job income, or financial situation, you want to go through the changes again. Regularly reviewing how things are going can make sure your tax strategy is still right for you.
Question 2. Which milestones in life could impact my taxes?
Your taxes can be impacted by different life circumstances. Some of these include getting married, getting divorced, having kids, starting a new job, getting a promotion, starting a business, buying or selling a house, inheriting something, or coming close to
Question 3. What is the importance of changing the tax strategy in general?
Adapting your tax strategy to your current income, family situation, investment portfolio, and financial goals is a great method to monitor your tax plan. It may also help identify potential tax-saving opportunities and avoid any unpleasant surprises regarding tax bills.
Question 4. How soon after the marriage should my tax plan be changed?
You may wish to update your tax plan after getting married. You should definitely verify your retirement accounts, Form W-4, filing status, and any other financial matters.
Question 5. Should I revise my tax plan when my income increases?
Without a doubt. A significant increase in income may affect your tax rate and your eligibility for certain credits, deductions, and tax-advantaged accounts. You will be better prepared for such changes if you update your tax plan in advance.
Question6. What are the things to include in a tax planning checklist?
Your tax planning checklist can include information on your income, filing status, dependents, retirement savings investments, business profits, charitable contributions, tax withholding schedule, estimated tax payments, and any significant family or financial changes.
