Tax Preparation vs. Tax Planning

Your accountant may do a great job preparing your tax return. But preparing your taxes and planning your taxes are two different jobs.

Tax preparation happens after the year is over. Your income has already been earned. The withdrawals have already been taken. Investments have already been sold. Your accountant takes everything that happened, reports it correctly and calculates what you owe.

Tax planning happens before those decisions are made.

The decisions

income earned, withdrawals taken, investments sold

Tax planning

before those decisions are made

Tax preparation

the return

JanAprJulOctJanAprThe year closes

The calendar year, with the filing season after it.

That distinction becomes more important in retirement because you may have more control over where your income comes from and when you receive it.

01Retirement gives you more tax decisions

While you're working, most of your income probably comes from a paycheck. You earn it when you earn it, taxes are withheld, and there isn't much you can do about the timing.

Retirement can be different. You may have Social Security and a pension coming in every month, but you may also have money in a Traditional IRA, Roth IRA and taxable investment account. If you need another $30,000 this year, where that money comes from can change your tax return.

If you need another $30,000 this year, where that money comes from can change your tax return.

You may also have decisions that aren't about spending at all. Maybe this is a good year for a Roth conversion. Maybe you're selling an investment with a large gain. Maybe you're deciding when to start Social Security. Those decisions can affect each other, which is why looking at taxes once a year when the return is being prepared may not be enough.

02Roth conversions are a good example

Suppose you retire at 62 and don't have to take required minimum distributions from your retirement accounts for several more years. Your income during those years may be lower than it was while you were working. Depending on the rest of your tax situation, that could create an opportunity to move some money from a Traditional IRA to a Roth IRA and pay the tax now.

Whether that makes sense depends on more than this year's tax bracket. You'd want to consider what you expect your income and tax situation to look like later, how much you convert, where the tax payment comes from and what else is happening on the return.

But here's the important part: the decision has to be made during the year. If you meet with your accountant the following March, they can correctly report whatever you did. They can't go back and make the Roth conversion you decided you should have done last year.

They can't go back and make the Roth conversion you decided you should have done last year.

That's the difference between preparing the return and planning ahead.

03Some decisions affect more than your tax bracket

Taxes in retirement don't always move in a straight line. A larger IRA withdrawal or Roth conversion can increase taxable income. Realizing a large capital gain can add more income in the same year. For people on Medicare, higher income can also affect future Medicare premiums because IRMAA generally uses tax information from two years earlier.

Company stock inside a retirement plan can create another decision. In some situations, special tax treatment for net unrealized appreciation may be available, but what you do with the stock before or during a rollover can matter.

1. 01A larger IRA withdrawal or Roth conversioncan increase taxable income.
2. 02A large capital gainadds more income in the same year.
3. 03Higher income, on Medicarecan affect future Medicare premiums, because IRMAA generally uses tax information from two years earlier.
4. 04Company stock in a retirement planmay qualify for special treatment of net unrealized appreciation, but what you do with it before or during a rollover can matter.

The four examples in the text. Which ones apply, and how much, depends on the return.

See where this year lands →

None of that means you should avoid income, conversions, investment sales or rollovers just to keep this year's tax bill as low as possible. It means you should understand the other consequences before making the decision.

04What tax planning looks like during the year

Tax planning doesn't have to mean constantly trying to find deductions or complicated strategies. Sometimes it's simply looking at the year before December 31.

• How much income have you received?
• How much have you withdrawn from retirement accounts?
• Have you realized capital gains?
• Is there room for a Roth conversion?
• Are there large expenses coming that will require another withdrawal?
• Could something you're doing this year affect Medicare premiums later?

Then you can decide what, if anything, should happen before the year closes.

Some years the answer may be a Roth conversion. Another year it may make sense to realize a gain, take an additional IRA distribution or deliberately do nothing.

The important part is that someone is looking before the decisions are locked in.

05Who is looking ahead?

This isn't a criticism of tax preparers. Preparing an accurate tax return is important work, and some CPAs and tax professionals also do extensive tax planning. Others are primarily hired to prepare returns. The problem is assuming someone is planning ahead when nobody has actually been given that responsibility.