Use Asset Location to Pay Less in Taxes and Get More Money out of Your Investment Portfolio

Block Woman surveys scattered piles of coins placed on a grid of squares

What if you didn’t have to save more than you already are, if you didn’t have to change what you invested in…and you could still get more money out of your investment portfolio? Pretty nice, eh? Well, you can.

May I introduce asset location.

Asset location is an investment strategy that puts certain types of investments into certain types of accounts based on the investment’s tax characteristics and the account’ tax treatment. The goal is to create larger after-tax returns for your investments. “After-tax” is the money you can actually spend. Pre-tax numbers are simpler to understand…but not as useful.

Vanguard estimates that proper asset location can increase after-tax return by 0..05 to 0.3% each year. Sounds…kinda small. But if you compound that over years, and talk about it in dollars and not percentages, it can sound…kinda big.

In this post, I’ll describe a lot of the nitty gritty of asset location, and I’ll end with how we use it here at Flow for our clients’ investment portfolios.

This Is the Icing, Not the Cake.

You do not need asset location to be a successful investor. It is icing on the investment cake. That cake’s ingredients?

  • Broad diversification. Owning not 1 stock or 10 stocks, but 1000 stocks.
  • Low cost
  • An appropriate “asset allocation” for the amount of time until you need the money. That is, the balance of stocks and bonds in your portfolio. Yes, we’re talking asset ALLOcation vs. asset LOcation. Sorry about that! I don’t pick the names!

(You can learn more about our beliefs about what constitutes good investing, in this blog post.)

To boot, the younger you are and the smaller your investment portfolio, how much you save is usually more important than all those things. 

But if you’ve already got the cake, and you’ve got the personal wherewithal to ice the cake, or if you’re working with a financial planner whom you’re paying to ice the cake, then yeah, let’s do this thing.

The Rules of Asset Location

Here are the rules that govern asset location:

Rules based on tax-efficiency:

  • Put your tax-efficient investments in your taxable accounts.
    For example, a total US stock market index fund. “Tax efficient” means your investment doesn’t produce much investment income (interest, dividends, capital gains distributions) during the year.

  • Put your tax-inefficient investments in an IRA or 401(k) (or other tax-protected account).
    For example, a taxable-bond fund.

Rules based on growth potential:

  • Put low-growth investments in a traditional IRA or traditional 401(k) (or other pre-tax account).
    For example, a total US bond-market fund.

  • Put high-growth investments in a Roth IRA, Roth 401(k) or HSAs (or other after-tax or tax-free account).
    For example, an S&P 500 fund.

One more rule that doesn’t fit neatly above: Put international-stock funds in taxable accounts. These funds typically pay foreign taxes, and if you hold them in taxable accounts, you can get a foreign-tax credit for those taxes paid, reducing your US taxes. If you hold them in a tax-protected account, you can’t get that credit.

Put ‘em together and what have you got?

Bippidi boppidi…oh wait, no.

You get a decision matrix like this:

Why Does Tax Efficiency Matter?

If you were retired, it’s possible that having investments producing income throughout the year wouldn’t be a bad thing. You’ll need money to live on, after all! You can use that investment income (interest, dividends, fund distributions) as that income.

But if you’re still working, your job provides all the income you need (god willing). You don’t want to have to pay taxes on income you don’t need. So, we want to minimize taxable income coming from your investments.

Which means we put tax-efficient investments in an account where you do pay taxes, because those investments won’t create much taxable income. And we put tax-inefficient investments in accounts that are tax protected, because regardless of how much income your investments create, you don’t owe taxes on it.

Why Does Growth Potential Matter?

Because we want to minimize the bucket that the government can take taxes out of and maximize the bucket that you own 100% yourself.

Let’s say you retire and have a $1M portfolio. The after-tax size of your portfolio varies depending on how much of your portfolio is in a pre-tax IRA vs. a Roth IRA. The bigger your Roth IRA is relative to your pre-tax IRA (for the exact same total portfolio balance!), the more money you will have to spend.

In this chart, you can see that when the $1M is split evenly between a Roth IRA and a traditional IRA, your after-tax portfolio is worth “only” $840k. (We’re assuming a marginal (i.e., top) tax rate of 32%.)

But let’s say you used asset location over many years, putting your high-growth investments in a Roth IRA and your low-growth investments in a pre-tax IRA. As a result, your Roth IRA is worth $600k, and your traditional IRA $400k. In this scenario, your after-tax portfolio would be worth $872k. Same $1M total portfolio…but a bigger Roth bucket gives you more money to spend.

Follow these rules gently, not obsessively.

These are guidelines. You can get a lot of the benefit of asset location by adhering only loosely to these rules.

You don’t have to put all your stock holdings in a Roth or even taxable account. It’s okay to have some in a pre-tax IRA! Just get a good chunk of your stock holdings (especially if they’re tax inefficient) in your Roth IRA to increase your lifelong tax savings.

Balance Optimization (Icing) with Simplicity

Asset location is easy enough to do, at a high level.

The more narrowly defined your investments, the more exacting you can get in your asset location…but at the cost of portfolio simplicity. So, I’m not sure you should get that exacting.

For example, a high-level implementation of asset location would mean getting most of your stock investments into a Roth IRA and most of your taxable bond investments into a traditional IRA.

In contrast, let’s say you break your portfolio down into individual stocks, commodities, micro cap US stock funds, small cap, mid cap, large cap, both growth and value, equivalent complexity on the international front, private-company stock, cryptocurrencies, etc. You now can pick the best account for each of those 10+ types of investments to go into. That’s harder to set up in the first place and harder to maintain.

I recommend getting most of the value of asset location with the least amount of setup and maintenance required. Asset location is optimization enough unto itself. I don’t believe you need to optimize the optimization.

The Challenges of Asset Location

An asset-location strategy is a multi-year (-decade) commitment. As with pretty much any investment strategy, there are challenges that you should really think about before you commit to it.

Each Account Will Perform Differently.

I used to work at a financial advisory firm that did not use asset location. They invested all of a client’s multiple accounts the same.

If the client’s target asset allocation was 90% stocks/10% bonds, then by gum, their taxable account was 90% stocks/10% bonds, their pre-tax IRA was 90% stock/10% bonds, their Roth IRA was 90% stocks/10% bonds…and all the spouse’s accounts were also 90% stocks/10% bonds.

I asked the lead advisor one day why they didn’t use asset location. He explained (I paraphrase) that a lot of clients couldn’t handle the fact that each account would perform differently than the others, and that their spouse’s accounts would also perform differently than theirs.

Your all-bond pre-tax IRA would grow 3% in a year, and your spouse’s stock-heavy taxable account would grow 16% in one year. Or one loses 3% while the other loses 20%. That doesn’t feel good.

Asset location is a portfolio-level strategy, not an account-level strategy. That means you have to be prepared for each individual account to perform differently. Your focus should be on The Total Portfolio. How did all your accounts perform together?

Big Money Movements In and Out of an Account Can Create a Challenge.

Let me tell you a story about difficulties we ran into when implementing asset location in a client’s portfolio.

We were managing this client’s Financial Independence (aka Retirement) portfolio, which consisted of a taxable account, a traditional IRA, and a Roth IRA. The portfolio’s asset allocation was 85% stocks/15% bonds. As prescribed by the basic asset location rules, all her bonds were in the traditional IRA.

Then we helped her roll that traditional IRA money into her 401(k) so that we could do a backdoor Roth IRA for her. Now, with her IRA emptied out, her asset allocation was…100% stocks. Eeek.

We needed more bonds. How to get them? We had two types of accounts to put them in: her Roth IRA and her taxable account.

I didn’t want to put them in her tax-free Roth IRA, as that’s the account where I want to put our “growthiest” possible investments.

That left her taxable account. But in order to buy more bonds, I’d have to sell some of the existing stocks, creating a taxable gain. She’s mid-career as a director at a big tech company. She’s earning a bunch of money, at a very high tax bracket. I really don’t want to create capital gains taxes if possible.

In her case, thankfully and coincidentally, around the same time, she received a gift from a family member of a bunch of a single stock. Whenever a client has a concentration in stock like that, we create a diversification strategy. In this case, part of that strategy was to use the sales proceeds to buy bonds.

You can perhaps see how, if she didn’t have the luck of that big gift, we likely would have ended up doing something “suboptimal” in either her taxable account or her Roth IRA in order to achieve the more important target of getting bonds back into her portfolio (i.e., getting her asset allocation back on target).

This same thing can happen when you do a big Roth conversion. Before the conversion, you have all sorts of pre-tax money, and you can hold bonds there. After the conversion, you have less pre-tax money and more Roth money. How will you make sure that the portfolio’s asset allocation is still on target?

It Makes Your Investments More Complex.

One benefit to investing all your accounts the same way is that, if you put more money into an account or take money out of an account, it’s easy to figure out how that account should be invested with its new (higher or lower) balance: The exact same as it was before. Was it 90% stocks/10% bonds before? It still is.

If you use asset location, every time you add a lot of money to or take it out of an account, or every time you do your annual “rebalancing” of your portfolio, you have to figure out how to change the asset allocation in each account to ensure that the total portfolio’s asset allocation is still correct (remember, the asset allocation is more important!), while still obeying the basic rules of asset location.

Tax Laws Can Change, Undercutting the Value of Asset Location.

The value of asset location comes from the fact that you have to pay taxes on investment income and withdrawals from pre-tax accounts. The higher the taxes, the bigger the value of asset location.

As tax law changes, asset location could become less valuable. (Of course, it could go the other way, too.) Certainly, if tax rates fall, asset location becomes less valuable. Already, the value of putting real estate investment trusts (REITs) in tax-protected accounts (IRAs, 401(k)s, HSA) isn’t as great as it used to be, because now you can get some tax benefits by holding real estate in a taxable account.

What We Do at Flow

At Flow, in our clients’ portfolios, we follow the good ol’ 80/20 rule: we want to get 80% of the benefits of asset location with 20% of the work (and complexity).

Here’s our focus:

  • Roth IRAs and HSAs get stock funds.
  • Pre-tax IRAs get taxable-bond funds.
  • Taxable accounts get everything else.
    • If we need more bonds in the client’s portfolio, we’ll often use tax-free (aka, muni) bond funds in the taxable account.
    • We use broad market index funds, so all our stock funds are tax efficient, whether they’re here in the taxable account or in the tax-protected Roth.

This strikes me as a good balance of simplicity and tax optimization. Other advisors with good investment philosophies and implementations do it differently. As I’m fond of quoting:

“There is no perfect portfolio. There are many perfectly fine portfolios.”

Do you want your investments managed in a way that balances optimization with your ability to understand what’s going on? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

More Strategies to Save You Taxes In Case the Tax Cuts and Jobs Act Expires in 2026

A shadowy Block Woman views a yellow ball labeled with red initials TCJA almost fully hidden below the horizon of a blue and green sea.

Big tax changes are a’ comin’. Maybe. In our last blog post, I discussed one big strategy to take advantage of the possible expiration of the Tax Cut and Jobs Act: the fabled Roth conversion.

The TCJA went into effect on January 1, 2018. All of the TCJA’s changes to tax law will expire at the end of 2025—and tax rates and other rules go back to the pre-2018 levels—unless Congress renews it.

In this blog post, let’s cover a few more strategies that might end up being really helpful to have done if the TCJA does indeed expire. But remember, because we don’t know whether the TCJA tax laws will expire or be renewed, you only want to make moves now if you’ll still be okay regardless of whether Congress renews it or lets it expire. Don’t go bettin’ the farm on Congress doing or not doing something.

And as with the previous blog post, it’s going to be Very Helpful to have a competent CPA on your team to help model the tax impact of any of these strategies.

Exercising Non-Qualified Stock Options (NSOs)

Remember how (and if you don’t, go back and reread our last blog post) I recommended that you consider converting pre-tax money in your IRAs or 401(k)s to a Roth account, because tax rates are low now compared to what they will be if the TCJA expires? And we want to incur taxable income when tax rates are lower?

Well, the exact same logic applies to the idea of exercising non-qualified stock options (NSOs).

When you exercise an NSO, you immediately owe income tax on the “spread” between the exercise price and the value of the stock.

Let’s say you exercise one NSO at a strike price of $1 with a share price of $10 (be that the price on the stock market for a public company, or the 409(a) value for a private company). That gives you $9 of taxable income.

Most people aren’t thinking about just one option. So, let’s think about 10,000 NSOs. In the exact price scenario above, you’d immediately have $90,000 of taxable income.

Behold the tax brackets and tax rates below, which is what they are now, and what they will be if the TCJA expires. Imagine that you’re single and your salary + bonus is $500k/year. If you exercise NSOs now, that generates an extra $90k of taxable income, all of that will be taxed at 35%. If you exercise post-TCJA expiration, then a little of that $90k will be taxed at 33%, a little at 35%, and most of it at 39.6%. Which, let’s review, is higher than 35%.

If you look long enough at the chart below, you can see that in some income scenarios, you’ll actually have a lower top tax rate post-TCJA than now. You’d need to run the numbers for your own specific situation to make sure.

Source: fpPathfinder®

Consider doing this: Exercise NSOs now, especially in private companies, if it would generate taxable income in a lower tax bracket than post-TCJA expiration. If you have NSOs in a public company, I’m usually of the opinion that you shouldn’t exercise NSOs until you’re ready to exercise and immediately sell, and that having the right amount of leverage is a good tool for determining when to do that. That’s probably still more important than gaming tax rates.

Exercising Incentive Stock Options (ISOs)

Surprisingly, most people I talk with who have ISOs seem to know about Alternative Minimum Tax. (Someone out there has been doing some good employee education!) The understanding sometimes stops right there: this tax exists, it’s related to ISOs, and, uh…tax bad?

For a short primer/reminder on AMT, read this blog post, the section entitled “Mistake #3: Forgetting about Alternative Minimum Tax on ISOs,” from our friends at McCarthy Tax.

What’s important in this blog post here is that the likelihood of having to pay AMT when you exercise ISOs will go up dramatically if the TCJA expires. You can usually exercise some ISOs without triggering AMT because there’s an “exemption” amount of AMT income before the tax kicks in.

Let’s say you exercise one ISO at a strike price of $1 with a share price of $10. That gives you $9 of AMT-eligible income. That income will likely not be subject to any tax because it’s below the exemption threshold.

At the other extreme, let’s say you exercise 100,000 such options, for $900,000 of AMT-eligible income (and then you hold the shares for at least a year). Yeah, you’re likely going to have to pay AMT.

You want to be pretty clear on where the tipping point is from “I don’t owe AMT” to “I owe AMT.”

That tipping point is determined in large part by what the AMT exemption amount is. The higher the exemption amount, the less likely you will have to pay AMT on your ISO exercises. You can see in the table below that right now, you can incur $133k of AMT-eligible income (as a couple; $85k as a single person) before triggering the tax. That threshold will drop meaningfully if TCJA expires: drop by roughly $29k for married couples filing jointly and roughly $19k for people filing taxes as Single.

Source: fpPathfinder®

Okay, what are you supposed to do with those numbers? Let’s continue with the example just above.

You can incur roughly $19k more AMT-eligible income now than you would be able to under the rules if TCJA weren’t in effect (all else held equal in your tax situation). So, with $9 of AMT-eligible income per option exercised, you could exercise roughly 2000 more ISOs now without triggering the Alternative Minimum Tax bill, than if you were exercising under tax rules without the TCJA in effect.

So, yes, you still have to pay the exercise price on that extra 2000 options (i.e., $2000, in this example), but you don’t have to pay anything more in taxes. Pretty sweet, eh?

Consider doing this: If you’re sitting on some exercisable ISOs (most likely that means they’re vested, but it could also mean you have early exercise/83(b) exercise available to you for unvested options), exercise ISOs now, up to the currently-higher AMT exemption limit.

Yes, you’re still putting your exercise price money at risk…but you’re not putting any money at risk paying taxes. You have up until the end of the year to do this. And then again in 2025.

[Note: Paying AMT isn’t the end of the world. If you pay it, you now have an AMT credit in your tax return, and if you make sure to carry it forward onto all subsequent tax returns, you have a chance of using that credit up in future years, thereby “getting back” any excess tax you paid in your AMT year. But, you know, it’s still nice to avoid paying it in the first place, as receiving the credit back isn’t guaranteed and also $1 now is better than $1 in 5 years. If you want to learn more about the AMT credit, see this blog post, the section “Mistake #4: Forgetting about the AMT Tax Credit”]

Increase your ability to exercise ISOs without AMT by increasing your ordinary income.

The higher your ordinary income, the higher your AMT income can be before triggering the tax. (This fact is independent of this TCJA discussion.) And increasing your ordinary income—by pulling future income into this year or 2025—might be a reasonable strategy to pursue in and of itself because your tax rates might be lower now than later.

What are some strategies for increasing your ordinary income?

In the tech world, it’s usually if you have non-qualified stock options to exercise. As discussed above, the spread between the strike price and share price is taxable ordinary income in the year you do the exercise. So, exercise more NSOs. Pay taxes on those (maybe at a lower tax rate than you’ll have in the future?) and then exercise even more ISOs without triggering AMT.

If you have any self-employment income or any other income whose timing you have control over, you could also consider accelerating income earlier rather than in later years.

Delay charitable contributions

The primary reason you should donate to charity is that you want to give money to a deserving cause or person. If you want to keep on keeping on in your annual charitable contributions, I APPLAUD YOU.

But if you’re already going to donate, you might as well make it as tax efficient as possible, eh?

There are two reasons that delaying charitable contributions might save you taxes:

#1 You save more when tax brackets are higher. If you are currently at a 37% tax bracket (the highest current tax rate) for every dollar you donate to charity (and itemize on your taxes), you save 37¢, which means it costs you 63¢ to donate that dollar. If you are at a 39.6% tax bracket (the highest rate in a post-TCJA world), you save 39.6¢ for every dollar you donate to charity, which means it costs you 0.604¢ to donate that dollar to charity.

Purely from that perspective, it makes sense to donate money in years when you’re in a higher tax bracket.

If you think tax brackets could rise in 2026, maybe it’d behoove you to delay charitable giving until 2026, when you could “bunch” charitable contributions from 2024, 2025, and 2026 into 2026. That way you’d get the benefit of bunching (a strategy that can be useful no matter what the tax-rate regime) and you’d be saving taxes at higher tax rates.

I wrote a series of blog posts about creating my family’s charitable giving plan, and it covers tactics we employed to make it more tax efficient, like donating “appreciated securities” instead of cash and the just-mentioned “bunching” of multiple years’ worth of donations into one year.

#2 You’re more likely to itemize—and actually get tax benefits—if TCJA expires. Also changing if TCJA expires is the standard exemption: it’d go down a lot:

Source: fpPathfinder®

You also will be allowed to itemize much more of what are often people’s two biggest expenses: mortgage interest and state and local taxes.

Right now, you can itemize interest on mortgages only up to $750k. That’d change to $1M. (And in places like the Bay Area and NYC, it’s reeaaaaallll easy to get a mortgage that big.)

Secondly, right now you can deduct only $10k of your state and local taxes (known as SALT). Again, if you live in California or NYC, your state and local taxes are likely way more than that.

Thirdly, and probably less impactfully, is that you could once again deduct the fees associated with using an investment advisor. (Thought I’d throw that in there for, you know, self-promotion’s sake.)

Source: fpPathfinder®

So, now you have a lower standard deduction and you’re being allowed to itemize more things, meaning it’s easier to get to the point where it’s worthwhile to itemize deductions because they exceed the standard deduction.

Consider doing this: Delay your charitable contributions to 2026. Between potentially higher income tax rates at that point, and the increased ease of itemizing deductions over taking the standard deduction, this could save you meaningfully in taxes.

Please return to my first comment in this section: the primary reason to donate money is to help people or causes, not to save in taxes.

If you're high net worth, get more assets out of your estate.

There’s too much to think about here, for this one blog post. I would absolutely encourage you to talk about this with your estate planning attorney (and/or your financial planner) .

What’s going on? When you die, any money in your estate above a certain threshold will be subject to a federal estate tax of up to 40%. (Look here for details. Some states also have estate/death/inheritance taxes, but we’re not discussing those.) Right now, that exemption is $13,610,000 per person. If TCJA expires, it’ll drop back down to what is currently estimated at $6,810,000.

Source: fpPathfinder®

Which means that if you have $10M now and die, your estate won’t have to pay any estate taxes and your heirs get all your money. If you were to die in a TCJA-expired world, $3,900,000 of your estate would be subject to estate tax, and your heirs would lose a lot of money to estate taxes.

Maybe you don’t have $10M now. But, you do have $5M, and if you live another 20+ years, and that money is invested and grows, you will have a bunch of money when you die. And then your heirs could still miss out on a lot of money because of estate taxes.

In either case, the overarching strategy being widely discussed now is to move money out of your estate now, when you have that big ol’ $13,610,000 lifetime exemption available to you. You can move your money out of your estate in a variety of ways, from plain vanilla (like funding your child’s 529 college savings account) to more complicated (like family limited partnerships and Nevada Asset Protection Trusts…no, I don’t actually know how these work, I’ve simply spoken with estate planning attorneys who do).

There is so much more to this discussion. Way more information is necessary from attorneys far more knowledgeable than I. This mention is only an amuse-bouche.

The benefits of moving money out of your estate now are the more obvious: Possibly saving your heirs a lot of estate tax.

In my opinion, there are a couple of major downsides to moving money out of your estate now:

  • Complexity: Your financial situation is almost certainly going to get more complex, with more accounts or legal structures to keep track of, and possibly changes to how you access your money/get income. Simplicity is worth fighting for.

  • Reduced access/flexibility: Your access to your money is almost certainly going to be more constrained, and possibly just outright reduced. Moving money out of your estate more or less means that it’s no longer yours to control and use as you want.

    I believe that the younger you are, the more important this is to consider. With so many years of life ahead of you, life is nothing but Uncertainty. Flexibility is a powerful tool in such circumstances.

    As one of my favorite estate planning attorneys observed, you might want to retain all your money unencumbered because, who knows! You might want to emigrate to a different country, buy your own baseball team, start a business, or start a foundation. And who knows what kind of adult your three year old is going to turn into in another two decades.

If you’re 80 and have 10, maybe 20 years left, this decision is one thing. But if you’re 40 and have two young kids and have half a century of life unfolding in front of you? Putting any of your money out of your control is, in my opinion, a risky gambit.

To boot, who knows what estate rules will be when you eventually die (hopefully, decades from now, by which time Congress will likely have changed the rules another 10 times)?

Consider doing this: Talk with an estate planning attorney who is familiar with the strategies necessary to move money out of your estate. But do this well before the end of 2025, because they are going to be slammed by then! It’d be like trying to hire a CPA in March to do your taxes by April 15. By which I mean: Good luck with that, yo.

Blog posts like this actually make me a bit anxious. There’s so much finicky stuff to keep on top of! I can only imagine how thinking about this must affect people who aren’t financial planners.

Just try to keep in mind that these strategies are not the essence of personal finance. The essence of personal finance is: spend less, save more, and don’t do anything stupid (according to Dick Wagner). If you’re not doing those things yet, focus your effort there first!

Would you like to work with a financial planner who can help proactively identify opportunities like this and then figure out whether they’re useful for you and your finances? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

Should you do a Roth conversion before the (possible) expiration of TCJA in 2026?

A shadowy Block Woman views a yellow ball labeled with red initials TCJA partially below the horizon of a blue and green sea.

As you might know, there’s a huge, all-encompassing change to tax law potentially coming up at the end of 2025. If it happens, you will almost certainly be big-time impacted.

What is that all-encompassing change to tax law? It’s the expiration of the Tax Cut and Jobs Act, which went into effect on January 1, 2018. All of the changes the TCJA ushered in will expire at the end of 2025—and tax rates and other rules therefore go back to the pre-2018 levels—unless Congress renews it.

It’s anybody’s guess whether Congress will renew it.

There are many provisions in the TCJA that really benefit our clients. If you, like our clients, are in tech, make good money and/or have good wealth, and have various forms of equity compensation, you probably benefit, too.

So, it behooves us to look at what tax rules are in effect now that potentially will disappear come 2026, and ask ourselves:

Should we take advantage of TCJA tax rules while they still definitely exist (because they might not exist come 2026)?

Consider these strategies this year and next.

Given the “maybe?” nature of all of this, you don’t want to do anything that you’ll regret if the tax laws stay the same. So, you’re looking for strategies that will serve you well—or at least not hurt you—regardless of what happens tax-wise.

This is, may I remind you, the nature of almost all of personal financial planning: You’re making decisions based on what you think or hope will happen in the future, not on what you know will happen in the future.

How do you still make good decisions in an environment of such irreducible uncertainty? For each choice available to you, you need to think about all the possible outcomes of making that choice. If any of those outcomes is simply unacceptable, then that choice isn’t right for you.

If some outcomes are better or worse than others, but none of them would be catastrophically bad for you (financially or emotionally), then it could be a reasonable choice to make.

For example, let’s say you work at a pre-IPO company. You have stock options. You could exercise them now, paying not only the exercise cost but also the associated tax bill. You can’t know what will happen to the company, and more specifically, the stock, in the future. Let’s say the stock does poorly and you lose all that money.

  • If that means you’d lose your emergency fund and throw your retirement plans off track, then that’s not a reasonable choice.
  • If that instead means you can’t take that One Vacation, but you’re more or less okay with missing it, then okay! Go forth and take that risk.

Below I discuss one strategy to consider before the TCJA expires (maybe): Roth conversions (and the corollary: contributing Roth instead of pre-tax). Later this month, I’ll publish another blog with the other strategies I think are worth considering:

  • Exercising ISOs
  • Delaying charitable contributions
  • All sorts of potentially very complicated stuff to reduce the size of your estate (for those of you who already have millions of dollars)

I’m covering only those strategies that I think are most likely to affect our clients (and therefore you, if you’re like our clients). The changes made by the TCJA are vast and beyond the scope of this blog post.

If you want to know more about the whole TCJA “thing,” you can find articles that are broader in scope from the likes of Schwab or Forbes or any number of financial advisory firms focused on other clientele.

Why talk about this now?

The changes may or may not happen, and making giant decisions based on a possibility is often a bad idea.

But we’re talking about it now for a few reasons:

  • There are some potentially powerful strategies you can use for 2024 and 2025 that will lose their power come 2026, if TCJA expires.
  • If you need to involve an estate planning attorney in any work, they’re gonna be slammed come the latter half of 2025. Best to reach out to them ASAP.
  • Even if it were entirely rational to wait for a while to discuss any of this stuff, you’re going to start seeing some “sky is falling” headlines, if you haven’t already. So, let’s discuss this in a useful manner before the headlines hijack your brain.

Roth conversions: Convert pre-tax IRA or 401(k) dollars to Roth

Why do we care about pre-tax and Roth?

Some background and edumuhcation about Pre-tax vs. Roth

Let me ask you a question: Would you rather save pre-tax when your tax rates are high or low?

The answer is High. If your tax rate is 39%, every dollar saved pre-tax saves you 39¢ in taxes. If your tax rate is 25%, every dollar saved pretax saves you 25¢. Saving 39¢ is better.

Now, would you rather save after-tax (i.e., to a Roth account) when tax rates are high or low?

The answer is Low. At a 39% tax rate, you pay 39¢ in taxes for every dollar you save to a Roth account. At a 25% tax rate, you pay 25¢ for every dollar you save to a Roth account. Paying 25¢ is better.

That’s a useful, but simplistic, way of thinking about the pre-tax vs. Roth/after-tax question. For a bit more nuance:

When you take money out of pre-tax accounts (typically IRAs or 401(k)s) in retirement:

  • You will need to pay income tax on all of that money.
  • That income can also increase other costs, like Medicare Parts B and D premium and the taxability of your Social Security retirement income.
  • All money in a pre-tax IRA or 401(k) is subject to Required Minimum Distributions, meaning that you must take money out of those accounts starting at what is now age 73.

Sounds kinda crappy. Why would we put money into a pre-tax account? Why, to save money on taxes now, of course.

By contrast, Roth accounts are tax-free, and any money in those accounts can stay in there for your whole life, you never have to take the money out, and if you do, it’s not subject to taxes and won’t raise your taxable income in a way that will impact Medicare premiums, etc. But you don’t get any tax breaks now for any contributions or conversions into Roth accounts.

[Note: The “Roth vs Pre-tax” discussion is a multi-layered one. Some considerations are technical (comparing current tax rates with expected future tax rates). Some are emotional (I, for example, would rather just bulk up tax-free assets while I’m young and have strong earning power). This TCJA-inspired consideration has to fit into the larger Roth vs. Pre-Tax discussion, which is, alas! outside the scope of this blog post.]

Why now is such a good time to consider Roth conversions

I wrote a whole blog post about Roth conversions a little while ago. (If you think you want to do a Roth conversion, I highly recommend you read the whole thing. Oh, and work with a CPA to model the tax impact.)

In that post, I pronounced that one good opportunity for doing Roth conversions is when “You bet the federal government will raise tax rates.” Well….?! That’s precisely what we’re talking about here!

If TCJA expires, here’s how tax rates and tax brackets would change. Observe that not only do tax rates go up, but higher tax rates apply to lower bands of income, meaning that your tax bill could go up double-whammy style.

Source: fpPathfinder®

We already consider Roth conversions for clients who are having an unusually low-income year, clients who are taking a sabbatical, going back to school, got laid off and can’t find a job, etc.

Because of this TCJA thing, even if this is a totally “normal” income year, you should still look at doing Roth conversions. These might end up being anomalously low tax rates anyways, simply because of federal tax policy.

Keep in mind that doing a Roth conversion means you are volunteering to pay taxes before you have to. You could just wait for another several decades to pay taxes on this money. But you’re making a bet that by paying taxes now, you’ll pay less (over your lifetime) than if you pay taxes later. (So much delayed gratification energy going on here, it hurts.)

It’s always possible you could convert the pre-tax money, and the tax rates don’t go up. Lord knows there have been bountiful predictions for decades now that tax rates will (“have to!”) go up…predictions that have yet to come true.

Consider doing this: Ask your CPA to model for you how much you can convert from pre-tax to Roth (in your IRA or 401(k)) and still stay within the same tax bracket, or even one tax bracket up, along with the tax bill you’d incur in both cases. If you want to convert, remember you have to do so by year’s end. You can even convert some this year and some again next year.

Remember, you want to have cash or taxable investments to pay the extra taxes. You do not want to withhold any money from the IRA in order to pay the taxes.

Contribute Roth instead of pre-tax

Many of our clients have $100ks or over $1M in pre-tax accounts (IRAs or 401(k)s). That is a lot of money to consider converting. (In reality, it probably makes sense to convert only some of it.)

By contrast, annual contribution limits to all these retirement accounts are way way lower: $23,000 for 401(k)s and $7k for IRAs (plus some catchup for people 50 years old and up). So, “pre-tax vs. Roth contribution” can be a much smaller-scale decision.

It’s still worthwhile considering, however! And maybe, behaviorally speaking, it’s a lot easier to contribute Roth (and not reduce your tax bill) than it is to convert to Roth (and intentionally increase your tax bill, possibly by a lot). Progress, not perfection, people!

Many of you likely have access to, and perhaps are even saving to, after-tax contributions to your 401(k) (aka, mega backdoor Roth). In that case, you’re already getting lots of after-tax/tax-free money into your retirement portfolio. Maybe that takes the pressure off shifting even more money into that tax-free status.

Consider doing this: Saving to your 401(k) Roth instead of pre-tax, for the rest of this year and in 2025. You could switch back to saving pre-tax if TCJA expires and tax rates jump up.

It’s hard to figure out how all this affects you!

I don’t know if you’ve noticed this, but our federal tax code is complicated. Like, really, really complicated. And getting more so every year. (Be sure to give your friendly local CPA a sympathetic glance, and maybe a cookie, next time you see them.)

The tax code is so intricate and interrelated that you can’t ever glibly proclaim that the change of <this one thing> will affect your taxes <in this specific way>. You need tax software because you need to effectively process your entire tax return in order to get a reliable answer about any single thing. It’s an unfortunate reality.

For example, if you live in California and have a mortgage and earn a lot of money, the higher tax rates will hurt you, but your ability to deduct more of your mortgage and more of your state income taxes (as illustrated below) will help you.

Source: fpPathfinder®

To make good decisions confidently, you need to work with a tax professional who has software that can model your entire tax situation under TCJA tax rules vs. your tax situation if TCJA expires.

Alright, friends and strangers. See you in the next blog, for more discussions of strategies you should start considering before the end of this tax year. Tootles.

Would you like to work with a thinking partner who can help you to discover and define your goals, and use that to help make your best financial decisions? Reach out and schedule a free consultation or send us an email.

Sign up for Flow’s twice-monthly blog email to stay on top of our blog posts and videos.

Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.