As California residents, we pay a hefty tax bill to enjoy the sunny beaches, rugged mountains, stark deserts, and lush forests of our beautiful state. But the truth is, our state taxes may only increase. The pandemic has created a widening budget deficit in California, (1) prompting members of the state legislature to propose a tax hike for the wealthiest of California residents. (2)
Sadly, many residents and business owners are leaving California for more tax-friendly states. (3) But if leaving isn’t an option or you simply don’t want to give up the California lifestyle (we get it), you may need to do strategic tax planning to reduce your tax liability.
Your financial advisor can help you optimize comprehensive tax-savings opportunities and other tax-planning methods based on your unique situation. For the financially savvy, here are some tax-planning basics you can use to begin the conversation with your advisor.
Build A Tax-Friendly Portfolio
Tax inefficiency within your investments is one of the biggest obstacles to building wealth, but it’s surmountable with the right planning. Your portfolio should be diversified not only for risk management, but also according to how your investments are taxed. Investments that are taxed differently can efficiently reduce your tax burden.
Municipal bonds and annuities may not provide the returns that stocks and real estate investments can produce, but the tax savings could just be worth it. Interest earned from municipal bonds and some types of annuities are not subject to tax, whereas capital gains from stock market interest or real estate sales are taxed at your highest rate. If you’re only earning taxable interest or income, those tax liabilities will eat away at your returns.
Some investors are choosing to convert portions of their 401(k) or traditional IRA to a Roth IRA. Conversions made at strategic intervals allow the investor to pay taxes on that money sooner, rather than paying higher taxes when tax rates (inevitably) rise. With the news of the tax-hike proposals by the state legislature, now may be a good time to consider a Roth conversion.
Strategize Tax Deductions
Tax deductions lower taxable income, which is attractive for wealthy individuals looking to reduce their tax liability. One option to lower your taxable income and plan for your future is to purchase long-term care (LTC) insurance, which is tax-deductible. Many people are taking advantage of LTC insurance as an affordable way to build LTC costs into their retirement plans.
If you’re a business owner, you may have even more to lose from proposed tax hikes. Some business owners are relocating from California to more tax-friendly states like Florida or Texas, as is happening with tech businesses in the Silicon Valley region.
But for farmers and agricultural business owners, it’s (pretty much) impossible to relocate. You can’t simply pack up a farm’s worth of dairy cows or roll up your almond crops to move to Florida. So although you can’t just leave the state and easily rebuild your agriculture business from scratch, you do have options to mitigate your tax liability.
As you likely know, a common strategy is to increase qualified business expenses and deduct these on your tax return. Your financial advisor can help you decide when to make big purchases for your business that qualify as deductions. These purchases can benefit your business and reduce your tax burden when intentionally planned for.
Save More In Tax-Friendly Accounts
In my opinion, a good rule of thumb for anyone—business owner or not—is to save as much of your pre-tax income toward retirement as you can. Contributing more of your before-tax income to an eligible retirement account such as a 401(k) or traditional IRA can help build a more robust retirement, but also reduces your taxable income year by year.
Whenever possible, it’s a good idea to make the maximum contributions toward your 401(k), pre-tax IRAs, and HSA. You have until April 15th of this year to make contributions for the year of 2020. Contribution limits in 2020 are $19,500 for a 401(k), (4) $6,000 for an individual IRA ($7,000 if you’re over 50), (5) and $3,550 for an individual HSA ($7,100 for family coverage). (6)
Partner With An Experienced Professional
When you live in a high-tax state like California, tax planning is critical for wealth accumulation. The experienced team at Nichols Financial Strategies can help diversify your portfolio, plan for tax deductions, advise on tax-friendly savings, review your required minimum distributions, analyze your Social Security benefits, and more to help save you money. Schedule a consultation call with us at 559-440-6999 or by email at firstname.lastname@example.org.
Matthew Nichols is founder, CEO, and wealth advisor at Nichols Financial Strategies with more than 20 years of experience in the financial industry. He spends his days serving business owners and families, specializing in helping those in the agriculture industry proactively prepare for the unique challenges they face in a rapidly changing economy. Matt is an Accredited Investment Fiduciary® (AIF®) and holds his FINRA Series 7 and 63 securities registrations with LPL Financial and his California State Life & Health Insurance license. He’s also pursuing his ChFC designation and is dedicated to continuing his education and staying abreast of the latest financial trends and strategies. Matt’s mission is to help his clients transfer wealth from one generation to the next and work toward achieving their goals so they can spend more time on what they love most. Matt was born and raised in the California Central Valley and resides in Fresno with his wife, Christy, and their two daughters, Holly and Jillian. He enjoys golf, traveling, skiing, and spending quality time with his family. To learn more about Matt, connect with him on LinkedIn.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.