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Tax Planning

New Tax Bill: How to Plan During Tax Reform Ups and Downs

To help you navigate the uneasy waters of new tax legislation, here are three tips on how to plan during the ups and downs of tax reform.

Articles by Nick Holeman, CFP®

By Nick Holeman, CFP®
Financial Planning Expert, Betterment  |  Published: December 26, 2017

Consider keeping your political and financial views separate.

Focus on the quick wins available to you in any new tax situation, rather than immediately jumping to complicated (and usually expensive) tax strategies.

Plan to implement necessary changes to your tax situation quickly but cautiously.

The financial world is known for generating news headlines, and the Tax Cuts and Jobs Act is no exception. Before the bill passed, speculation on the GOP tax reform bill flooded the media, and the bill itself went through many revisions throughout the negotiation process. If you’re like many investors, you might still feel unsure of what to make of it all.

  • How should I interpret these proposed changes?
  • Should I act now, or wait?
  • What if details change before the final bill is passed?

The important thing to remember is that staying disciplined and planning ahead (both are principles of Betterment’s investment philosophy) are key drivers for financial success. To help you navigate the uneasy waters of new tax legislation, here are three tips on how to plan during the ups and downs of tax reform.

1. Keep political and financial views separate.

We always tell Betterment customers that, “regardless of whether a Republican or Democrat is in office, we will work hard to help grow your investments and save you taxes.” This nonpartisan approach to financial advice is important for Betterment, and important to each of our customers.

Politics and money can both be very emotionally charged topics. Combine the two into one discussion, and you have a recipe for irrational decision-making, even for even the most level-headed investors. Numerous experiments have been conducted on peoples’ avoidance of taxes. For example, which would you prefer:

  • A bond that pays $300 in interest, and is tax-free?
  • A bond that pays $400 in interest, but you will pay $100 in taxes?

In both choices, you walk away with an equal $300 after-tax return, yet 77% of people choose the tax-free bond, showing that people have an aversion to taxes that doesn’t align with rational economics. It is important to be aware of your bias and to keep your political views and financial views separate when it comes to your goals.

This is not to say that you shouldn’t voice your political opinion through voting, donating, or expressing your opinion. Your view is important. Betterment voiced our opinion strongly against the FIFO mandate that was being considered in the recent tax bill  because we believed the mandate would hurt everyday investors’ ability to achieve their financial goals.

But regardless of how the tax bill changes tax rates and deductions, we will make rational financial decisions that are rooted in evidence for each and every one of our customers, and we encourage our customers to take the same approach to your personal finances.

2. Focus on quick wins first.

The actual bill is 1,097 pages long. I have seen many articles discussing ways to save money under the new bill. Some of these recommendations have clearly been more clickbait than actual advice, such as “get lucky with timing your inheritance” or “move to Texas.”

My advice is to ignore the noise and instead focus on actions that are reasonable and feasible for you to take. I call them quick wins. Making extreme changes to your lifestyle or investing behavior just to save a few tax dollars may not be worth it, when you step back and do cost-benefit analysis. Often times, what seems to makes sense theoretically can end up costing more in tax-filing costs, complexity, and time. There are plenty of financial actions that are within your control and don’t require you to jump through flaming hoops. You should start with those scenarios.

For example, if uprooting your family to Florida because of the proposed limitations on the state and local tax (SALT) deduction sounds a bit absurd to you, you can still consider paying some of your income/property taxes by year-end, so you can maximize the deduction on your 2017 taxes.

Or if you will no longer itemize your deductions next year because of the larger standard deduction amount, you may want to accelerate some of your deductions to 2017 so you can fully utilize them. Rather than signing up for unnecessary medical procedures, consider accelerating your charitable donations instead. Betterment’s charitable giving feature is one straightforward way of doing so.

Another example is for small business owners. Before you consider forming a C-Corp to take advantage of the lower corporate tax rates, remember that such an action could complicate recordkeeping and tax filing. Depending on your situation, forming a C-corp may seem worthwhile to you, but you should start by simply re-examining whether a Roth or Traditional 401(k) is best. If your tax rate changes under the new laws, revisiting this could save you on taxes and it might be easier to carry out. Our RetireGuide tool calculates this for you automatically.

Some tax savings strategies are more costly or difficult to implement, and some require you to fundamentally change your lifestyle. Start with the quick wins that apply to your situation. Then you can turn your attention to other strategies that may be more expensive or complicated to execute.

3. Plan to implement quickly but cautiously.

I’ve had many customers ask me if they should make any changes to their finances now, in preparation for the tax bill being implemented. Their thinking is that they might be able to get ahead of any changes that might happen. I caution them to be careful about jumping the gun on tax legislation, even after a bill passes.

As Peter Lynch famously said, “Far more money has been lost by investors trying to anticipate corrections than has been lost in corrections themselves.” The same can be said of trying to predict politics. Trying to predict what will happen—or how policy turns into specific implementation practices—can often do more harm than good.

Even with the bill signed, there are bound to be new insights for everyday investors that emerge as the IRS implements the new policies.  So, as you plan changes to your finances, it’s important to be cautious.

Focus on the positives of tax legislation.

Any new tax legislation causes a great deal of excitement and anxiety for investors, but remember that changes to the tax code often lead to different opportunities in strategically planning your finances. Having a clear framework on how to navigate the ups and downs of tax reform can help you maximize those potential benefits.

Keep your political views separate from your financial views. Before getting too complicated, focus on quick wins that are easier to implement. And lastly, don’t jump the gun before the bill is actually law.

We will all be anxiously following the news as the new tax bill is put into place, but it’s nice to know that whatever happens, you have a plan in place for your finances.

Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional.

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