After you have filed your tax return, try to avoid just tossing a copy of it into your filing cabinet. According to financial experts, it could play a key role in terms of financial planning.
According to a recently released survey from the American Institute of CPAs, about 55% of American taxpayers have altered their financial plan based on information in their annual tax return, and about 27% make this a yearly practice. On the flip side, a survey by The Harris Poll in late 2020 found that 23% of Americans have no financial plan at all.
Regardless of which category you fall into, your tax return is a valuable tool in building or revising a financial plan, as it provides a succinct overview of your current financial situation.
“One of the biggest challenges with doing a financial plan is probably why so few do it: it requires a lot of information,” said Matt Rosenberg, who is a member of the AICPA National CPA Financial Literacy Commission. “You might as well turn and use that information from your taxes for planning.”
Here are a few ways that your tax return can help you in regards to financial planning.
Consider Changes to Your Family Structure
A good place to start is with the first lines of your 1040 form, which provides the basic information about your filing status. Are you married and filing jointly? Are you the head of your household? How many dependents do you claim? Consider any changes in the past year to your family structure, such as whether a child has gone to college or you have adopted a child.
This information is an excellent starting point for a conversation with your financial planning expert. Each family member who is part of your tax filing could have an impact in terms of estate planning and saving for college tuition, as well as spending for health and life insurance. Your financial planner can talk with you about your goals for each member of your family, as well as important documents you need to have updated and in place, such as durable financial power of attorney and a health care proxy.
Categorize Your Income
Your tax return will provide a concentrated, up-to-date snapshot of your income sources, including your wages or salary, your returns from investments, and Social Security income. With this information, you can categorize income as recurring, sporadic, or one-time, giving you a good foundation for establishing or revising your budget. When this data is combined with your expenses, you’ll know how much money you have left to apply toward your financial goals.
Reconsider Your Withholdings
Many financial planners advise that your withholdings don’t create a situation where you owe or receive a lot of money from the government. Rules governing withholdings have changed, and many Americans haven’t updated their withholdings accordingly. Your tax return will show how the amount withheld over the year aligned with the taxes you owe.
If you received a large return from the government, that means according to some financial experts that you have essentially given the government an interest-free loan for the past year. Conversely, if you owe money at tax time because you withheld too much, you will be charged a penalty.
While you will still pay the same amount of taxes in the end, adjusting your withholding ensures that you will keep the money in the interim.
Adjust Your Retirement Plan
As you refine your retirement plan, your tax return can help you make adjustments to keep your plan current and focused on financial security. Tax returns will show you the impact of your tax-deductible contributions to your retirement plan on your taxable income and help you make decisions such as how to best transition to Medicare or other insurance after you retire without severely impacting your income.
It’s also wise to annually review your beneficiaries, as circumstances can change from one year to the next. For example, in the unfortunate event that your spouse or child dies or you divorce, you’ll need to update your retirement accounts, insurance policies, and beneficiary designations, as these assets will be given to their designees, not through stipulations in a will.
Assess Your Charitable Giving
Rules have changed for charitable giving in recent years regarding itemized deductions, and the result has been that taxpayers are less likely to itemize their charitable giving and reap the tax benefits. Your financial professional can help you make decisions about how and where to direct charitable giving to maximize the tax benefits under changing laws. For example, you may want to condense several years’ worth of charitable giving into one year (rather than giving the same amount each year) so that itemizing these deductions will have more of an impact on your taxable income.
Regardless of your financial goals, examining your tax returns each year will allow you to assess your situation and make changes accordingly to protect and build your personal portfolio.