YNAB Podcast Episode 76: Taxes and Timing

Hello YNABers. My name is Jesse Mecham and this is podcast number 76 for You Need A Budget, where we teach you four… four rules to help you stop living pay check to pay check, get out of debt and save more money.

I’m not going to edit that out. I’m just going to leave that in. Most of you guys know that I make mistakes, so it’s staying in.

Today I’m going to be talking about taxes. Talking about mistakes, you make a mistake with your taxes, the worst thing is you won’t even know it happened – as you guys know from my podcast where I talked to my advisor, Casey, who you can also have advise you at [email protected] I have no financial interest in Casey’s success. I hope I don’t make him so busy that he can’t focus on me and my tax needs. I’m just kidding – sorry.

So, if I were a millionaire, if I had a lot of money, I would enjoy options when it comes to taxes. And I wanted to talk about this today. It’s an interesting topic. It’s a little bit advanced, but you can just consider how powerful it might be to be able to time when you actually incur taxable events. A taxable event is like when you have a baby, because you get child credit and you get another exemption on your tax returns; so if you could time a pregnancy it would be more tax advantageous to have the baby born just before the end of the year – like I was. I was born right before the end of the year because I wanted to save my parents some money. Of course, I was 60 days premature and that meant that they maxed out their deductible for my birth year and the following year, so my dad told me it didn’t actually help them at all. So think that through with those deductibles and things.

But when you time things, it can be big. Imagine that you’re a 65 year old multi-millionaire and you just maybe do some consulting gigs on the side, and your consulting contract income is low in one year because you haven’t felt like working as much. So you purposely pull out some of your tax-deferred money because you’re in a lower tax bracket. So you’ve got, let’s say, a 401K where once you pull money out you’re taxed on it. If you know that your income will be low for a year because you’ve taken less jobs or whatever, that would be the year where you would pull out some of that tax-deferred income because you’d be taxed in a lower bracket. If, on the other hand, you have a big payday one year with your consulting gig, landing some big contract, they were paying you all kinds of money, you wouldn’t take ANY distribution, as long as you weren’t forced to. The IRS does start to force you to do these things, I think, after 70 years old, maybe, to a degree. I’d check with your tax advisor. But you can see what would happen.

If you had $30,000 of consulting income one year where the year before you had $100,000, then in the year where you had $30,000 you may want to take out $40-50,000 from your 401K. You wouldn’t want to take $40-50,000 out of your 401K when you’d earned $100,000 because then you’d bump your taxable income up to $140-150,000 and you’d be paying that high rate for those people in those upper brackets for income taxes.

Imagine that you have a big donation that you’re set to make to your alma mater or something. You’re set to make this big donation, you’re limited to, I think, donating only up to 50% of your income in a year, but that would be the same year when you may happen to also pull a lot from your tax-deferred account or sell some things and recognize some capital gains, because those would be offset by your very large donation.

Maybe you make an investment and it has some losses in some way. That would be the time where you could say, “Well, I’m going to go ahead and exercise… not exercise. I’m going to go ahead and sell some investments that had gains with them so that I can offset the losses and have it basically be zero,” where you have no tax ramification for it. The timing – that’s where a tax advisor comes into play. TurboTax would never tell you this because it’s not smart enough, nor will it ever be. All famous last words. Who knows what it will be like in 20 years. But right now, TurboTax is not sufficient to be able to tell you, “Hey, Jesse, you’re going to pay tithing next year and you’re going to be paying tithing again this year, but next year you’re going to be earning a lot more money. So why not pay a lot… Wait a month. Instead of paying as much tithing in the current year, defer some of that tithing to next year.” Or even better – so you’re not withholding, you’re giving – you could flip that around and say, “Hey, if this year’s going to be a big year, and you’ve got the cash to be able to float this, you could prepay your tithing for this year, offsetting a lot of that big year income.” And then the next year, when you are expecting your income to go back down to normal levels, you wouldn’t need that tithing nearly as badly – you wouldn’t need the deduction, I should say, of the tithing, or any other charitable giving, nearly as much.

That type of timing can be very advantageous. It gets very interesting when you look at the standard deduction and you actually time your itemized deductions and double them up. You prepay a lot of expenses for the following year so that you have virtually no itemized deductions for that year. Then you can take the standard deduction. So you basically get the standard deduction in Year 2 and you get a big, fat itemized deduction in Year 1, instead of just having two medium itemized deduction years in both years.

I wonder if this would have been better with video. At any rate, that flexibility is what gives you power, and a good advisor is what gives you that knowledge to be able to do those types of things. We are talking about thousands and thousands and thousands and tens of thousands of dollars in tax savings by just doing things at a different time. Not spending any more or any less, just watching out on the timing of things.

So, until next time, follow YNAB’s four rules and you will win financially. You have not budgeted like this.

YNAB does not provide professional financial, tax, or investing advice. Always seek the advice of a licensed professional.