Why Tax Planning Matters!

At the start of the year, taxes are on everyone’s minds. The shared goal is to reduce your tax liability and keep more money in your wallet. There are many avenues for doing so, and a financial advisory firm like Nelson Financial Planning is well-equipped to help you find and take full advantage of the most relevant ones.

Recent surveys reveal that 90 percent of households with assets exceeding $250,000 want tax planning advice included in the financial services they receive. This notable shift in client priorities places tax advice and strategy higher on the list than retirement planning! As consumers become increasingly savvy about their finances, they want to optimize their tax situation alongside their investment strategies.

While specific guidance is always best, general advice is a good place to start. Today, we’re covering traditional IRAs vs. Roth IRAs and the Employer Retention Credit (ERC).

Choosing Between a Traditional and Roth IRA

Retirement plans go well beyond employer-sponsored 401(k)s. Traditional and Roth IRAs are two pillars of retirement planning that offer distinct tax advantages and considerations. Understanding the differences between each one can help you make the best decisions for your financial future after retirement.

Defer Taxes With a Traditional IRA

A traditional IRA is an individual retirement account with deductible contributions. The amount you invest into your account is subtracted from your taxable income, providing an upfront tax break. However, this immediate benefit comes with a long-term consideration: distributions taken in retirement are taxed as ordinary income. This setup may appeal to you if you anticipate being in a lower tax bracket during retirement when your distributions will be taxed at a lower percentage.

Enjoy Tax-Free Growth With a Roth IRA

A Roth IRA is funded with after-tax dollars, meaning contributions are not tax-deductible. The trade-off here is the potential for tax-free growth and tax-free withdrawals in retirement, assuming certain conditions are met. This makes the Roth IRA an attractive option if you expect your tax rate to be higher in retirement or you value the flexibility of tax-free withdrawals.

Eligibility and Contribution Limits

Both traditional and Roth IRAs have a contribution limit of $7,000 per year (or $8,000 for those 50 years old and above, thanks to the catch-up contribution). However, the Roth IRA includes income limits that restrict high earners from contributing directly to a Roth. The traditional IRA does not impose income limits for contributions, though income levels and participation in employer-sponsored plans may affect tax deductibility.

The Cost of a Tax-Free Retirement

The chance to enjoy a tax-free retirement often draws attention to the Roth IRA, especially with the option of converting a traditional IRA to a Roth. Such conversions allow taxpayers to pay taxes on pre-tax assets now in exchange for tax-free withdrawals later. The Roth’s tax-free growth potential is particularly compelling for younger investors, given the longer time horizon for investments to grow.

However, Roth conversions add to your taxable income for the year, potentially bumping you into a higher tax bracket and affecting the taxation of Social Security benefits or Medicare premiums. Clearly, deciding between these types of IRAs—or determining the suitability of a Roth conversion—requires careful analysis of your current tax situation, expected future tax rates, and retirement goals. Your decision is further complicated by ever-changing tax laws. For these reasons, it’s best to consult a tax professional before making your decision.

The Employee Retention Credit (ERC)

The Employee Retention Credit (ERC) has played a significant role in pandemic relief efforts, aiding employers who kept their workforce employed during the challenging times of 2020 and 2021. This tax credit, offering up to $26,000 per employee, aimed to offset the financial burden for businesses striving to maintain their operations and workforce amid economic uncertainty.

Initially, the ERC served as a critical support mechanism, incentivizing businesses to retain employees while the economy was partially shuttered. Eligibility for this credit was specific, targeting businesses that saw a considerable decrease in gross receipts or were unable to operate as usual due to mandated shutdowns. These qualifications aimed to direct assistance toward the businesses most affected by the pandemic’s economic fallout. In addition, the distinction between qualified wages and the interplay with other relief options like the Payroll Protection Program (PPP) highlighted the need for careful consideration before claiming the ERC.

However, the ERC’s popularity gave rise to opportunistic tax preparation firms charging significant fees to help businesses claim this credit. This development raised concerns, as some firms pursued aggressive tactics, sometimes leading businesses to claim the credit improperly.

The IRS’s response to this has included halting the processing of claims and proposing a settlement offer. This would allow businesses to retract their claims without penalty, acknowledging the challenges and confusion surrounding eligibility and proper claim processes.

Nelson Financial Planning’s Unique Approach

At Nelson Financial Planning, we integrate tax planning with our other financial advisory services for retired clients. With 40 years of industry experience, we are uniquely positioned to offer sound tax advice. Our comprehensive approach goes beyond simple tax return preparation to include trustworthy advice and accurate projections, helping you make informed decisions about your investments, retirement, and tax strategies.

When you’re ready to change your life with a successful financial plan that provides peace of mind for the future, please contact our office in Winter Park, FL.