Tax Planning is Overrated
I’ll admit it. I chose this blog title to be deliberately provocative. And yet, I don’t believe that I am wrong about this. I speak to many people who are wringing their hands over the tax implications of their financial decisions when they would be much better off spending that time gardening or watching sports.
While an obsession with taxes is not a uniquely American phenomenon, it does seem to dominate popular discourse to a level that does not seem entirely healthy to me. It certainly does not help that our government’s “solution” to pretty much every problem is fidgeting with the tax code.
It is also the case that much of personal finance media centers an “invest like the rich” narrative. As they say, the rich are different: Tax planning is way more important when you are in the plus-30% federal tax bracket. But for the average (read: not rich) household’s financial planning, a problem arises when, as the cliché goes, you let the tax tail wag the investment dog.
All things being equal, yes, paying less in taxes on your investments is better than paying more. But all things are not equal. Here’s what I mean…
Saving for retirement in a tax-advantaged 401(k) or IRA is great. But it is possible, and not at all uncommon, to overdo it. Yes, invest for the future…but don’t forget that there is lot of future before you turn 59 ½ and have penalty-free access to your savings. There is nothing wrong with including a plain old taxable investment account in your financial plan. What you lose in tax efficiency, you gain in flexibility.
I am a bit of a broken record when it comes to Health Savings Accounts (HSAs). Great for some, lousy for many. What I don’t like to see (similar to “over-using” retirement accounts), is a large, inaccessible HSA balance invested tax-efficiently for the distant future, combined with paltry savings for today. And yes, I have certainly seen this.
Raise your hand if someone has tried to sell you a life insurance product with the pitch that it will save you money on taxes. Did they demonstrate to you how much you — given your income and your tax rate — would save after the fees for this investment? Likely not.
Don’t misunderstand me. Understanding the tax implications of your investing decisions is a fundamental part of financial literacy. However, successful investing springs from your savings rate, matching your investments to your time horizon (i.e., when you plan to spend the fruits of your labors) and choosing a low cost, well-diversified portfolio. This is true no matter what your tax bracket is.
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