Opinion: Tax planning for long-term investments in an age of uncertainty

We have experienced significant market volatility over the past two years, which affects not only our current financial plans, but also our long-term investments and retirement goals. Navigating the uncertainty surrounding inflation and taxes can feel overwhelming, but it’s wise to consider preparing your financial assets for the unpredictability of the market and anticipating the possible impacts on your portfolio.

I always recommend that my clients seek out investments that minimize taxes, such as investments in retirement plans, mortgage interest, charitable contributions, college funds, and health savings accounts. But in addition to making sure you participate in plans and programs with taxes and retirement savings, here are some ways to protect your long-term finances in an unpredictable market, especially in the age of COVID-19:

1. Consider opening a Roth IRA backdoor

The Roth IRA backdoor allows high-income individuals and couples to put money into a Roth IRA for future tax-free savings that aren’t subject to minimum distribution requirements. Although there is no immediate tax benefit, you will be able to enjoy tax-free growth in the future – and several clients have used this strategy to save more tax-free money.

The Roth IRA backdoor is designed for those who have exceeded the current IRS limits for direct contributions to a Roth IRA. Because there is currently no income limit for contributing to a non-deductible traditional IRA, and there are no current limits that prevent an individual/couple from converting so much from a traditional IRA into a Roth as he wishes, this “backdoor” strategy presents a significant opportunity for tax savings.

To take advantage of this strategy, investors fund up to the IRS limit in a non-deductible traditional IRA. Because it’s non-deductible, there’s no immediate tax benefit, but once you “convert” that traditional non-deductible IRA to a Roth IRA, there’s no tax owed. on the total amount of the contribution. Once this conversion is complete, you will have effectively funded a Roth IRA and enjoy tax-free future income and growth.

Keep in mind that if you are under 59½, there is a five-year rule that requires funds from a converted Roth to remain in the account for at least five years. Otherwise, you may be subject to an early withdrawal penalty.

2. Assess the benefits of downside protection investments

In volatile market conditions, it may be a good idea to add investments to your portfolio that offer some element of downside protection. This buffer will protect your assets in the event of an economic downturn.

In truth, downside protection investments can be an essential part of any healthy portfolio, whether or not there is significant market volatility. Financial advisors often incorporate downside protection investments into their financial plans to ensure stability of important assets no matter what happens in the economy.

3. Be aware of the Alternative Minimum Tax (AMT)

Anyone whose gross income exceeds the AMT exemption amount should run the AMT calculation to see if they are subject to tax. For 2021, it’s $73,600 for singles and $114,600 for married couples filing jointly (NerdWallet). Historically, the majority of AMT is paid by taxpayers with incomes over $1 million.

If you are subject to the AMT, here is how to reduce its potential impact:

  • Maximize contributions to tax-deferred retirement plans, health savings accounts, flexible spending accounts, and tax-deferred compensation plans, where applicable

  • Use tax-efficient investments (ETFs/mutual funds) and/or tax-exempt bonds versus taxable bonds in your non-retirement investment portfolios

  • Maximize your charitable donations to help reduce your adjusted gross income

4. When in doubt, ask an expert

Certain tax policies and unpredictable market changes can inevitably affect your financial planning. If you are unsure how you will be impacted or what action to take next, consider contacting a financial advisor.

Financial advisors can be a valuable resource for up-to-date information on complex and changing policies. In particular, they can help you decipher:

  • Tax rates: Depending on how tax rates change in 2022, you may be affected by corporate and personal tax changes. This could have a major impact on economic growth, personal income tax, small business tax and capital gains tax.
  • Interest rate: As interest rates fluctuate, the cost of borrowing can affect your ability to borrow for a new home, business, college education, or other major investment. A financial advisor can help you anticipate these rate changes and develop a plan that fits your long-term goals.

As politics, tax rates and inflation impact the market, your financial plan may change. Flexibility is key, and if you’re willing to adjust your approach, your goals will stay within reach even in the face of market volatility. Powerful short-term adjustments could protect your long-term financial goals.

Faron Daugs, CFP, is founder and managing director of Harrison Wallace Financial Group.