Tax Planning vs. Tax Optimization

Know the difference and more tax vocabulary.

At Alpenrose, we urge our clients to have a thorough financial plan. Financial planning is evaluating your current and future finances by using known aspects of your financial state to make predictions about what can happen in the future, including cash flow, asset values, and withdrawal plans. With the help of financial planning, you will be able to predict where you will be in the years to come by evaluating where you are currently, what sources of income you plan to have in the future, which investments you plan to make, and your retirement plans.

Within the greater realm of financial planning, there are many steps for individuals to keep in mind. These steps include determining your goals, asset protection, retirement planning, and much, much more. Within these steps sits tax planning. Most simply put, tax planning makes sure you are thinking about how heavily you will be taxed through your income and capital gains. In the end, you want to be able to save the money you need for retirement, or reach whatever goal it is you have in mind.

There are a lot of steps and considerations to take when making a proper tax plan. One of these steps is tax optimization, which is easily confused with tax planning itself. Below, we’ve explained what the difference is along with some more tax vocabulary in order to assist you with your own tax planning.

Tax Planning

Having a solid financial plan would be useless if you forget to think about your taxes. Imagine putting in all the effort, making sure all your t’s are crossed and i’s dotted, but then you forget that you are going to have to pay taxes for all of the investments that were supposed to be earning you money.

Analyzing your financial situation or plan in terms of your taxes is called tax planning. The reason most financially-minded individuals tax plan is to ensure their tax efficiency by using their financial plan to choose tax-efficient investments and living decisions. Tax planning a very important part of a financial plan, because it reduces tax liability and allows you to save the most for your retirement and reaching other financial goals.

Similarly to financial planning, tax planning needs to be thorough. Steps of tax planning involve determining your goals and starting early, assessing your tax liability, looking at your risk level, and so much more.

When you are tax planning, you are making decisions in your portfolio that are tax efficient based on the size of your income or profits, the nature and timing of a purchase, insurance coverage, and the type of investments being made. Tax-favored investments, like IRAs, are highly regarded because the money collects tax-free until it begins to be distributed to the account holder, at the time of retirement.

An IRA, or Individual Retirement Account, is just one example of a way a person can tax plan, and it is also a good example of tax optimization, which can be explained further below. An IRA is one of the well-known ways an individual can save for their retirement.

Tax planning not only affects your retirement plans. It can also make differences in the future value of a portfolio and a person’s current standard of living.

Tax Optimization

Now that you understand the overarching idea of tax planning, you can better understand what makes tax optimization different. Tax optimization is just one of the steps.

Tax optimization [link to tax optimization page] involves bringing your financial plans to life through staying mindful of tax-efficient investments and decisions. This includes timing of income and purchases, types of investments, retirement plans, and how the taxes are filed.

There are so many different ways to optimize your taxes, depending on whether it is an individual or a business, how the income is made, and the tax laws of your country. Like most financial planning, there is no single tax optimization strategy that will work for everyone, but there are services that we can offer that can guide you through the process.

This is very important, because it allows for an individual or business to save money. Tax optimization plays a key role in your retirement planning.

Don’t do this alone. If you try to optimize your taxes on your own, you could be missing some of the tax deductions that you may not be aware of. We won’t let you miss out on saving your money.

By working with legal, tax, and accounting advisors, setting up structures, trusts, funds, or life insurance wrappers that benefit from specific tax treaties or other legal tax planning techniques can lead our clients to make significant savings in their tax bill.

More Tax Vocabulary  

Since we are talking about taxes, there can be a lot of terms that seem like the same thing. Here are a handful of words you will need to be familiar with in your tax planning adventure.

Tax efficiency: This is when you try to minimize your tax liability. One can use ETFs and municipal bonds, dividend reinvestment, and more.

Tax liability: The amount of taxation that a business or an individual builds up based on tax laws. Liability incurs from earning income, earning money on a sale, or other taxable events.

Taxable events: A taxable event is any event or transaction that can take place that results in tax consequences. This can include capital gain, receiving dividends, and more.

Tax compliance: This is ensuring that you are paying all of the taxes you are supposed to be paying. With changing tax laws, tax compliance can sometimes be a difficult thing to check. Luckily, there are tax compliance checklists that can assist you. Alpenrose is also equipped to guide clients through this step.

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