What is a Tax Triangle and Why Does it Matter

The Tax Triangle – a concept I utilize with our clients that we work with for years and years and years. It is a concept I use to illustrate where to position our money today so that we end up with the most favorable income coming to us in retirement… for tax purposes. But what is a Tax Triangle?

Point 1 – Tax-Free Accounts

At the pinnacle of this triangle is the tax-free earnings. These are my absolute favorites. I mean really, who doesn’t love tax-free money? The idea is that we place money into these accounts and it grows, and it does so tax-free! The idea is that in the future when we use this money, we won’t have to pay taxes on the earnings. These accounts are:

1. Roth IRA
2. Roth 401k
3. Health Savings Accounts
4. 529 Plans/Educational Savings Accounts
5. Cash Value Life Insurance (No really tax-free but can be…This one is special)

Point 2 – Tax-Deferred Accounts

Now, the next point on the triangle is what is called tax-deferred. These accounts are where you invest money, and it grows, tax-deferred. In other words, you do not pay taxes on it until you use the money. The accounts that fall into this category are:

1. 401k/IRA
2. Real Estate
3. Annuities

Point 3 – Taxable Accounts

The final point of the triangle is present taxable. That means these accounts are taxable every year. Examples of those accounts are:

1. Savings Accounts
2. Brokerage Accounts

RELATED READING: How to Reduce Taxes on Retirement Accounts

Why does all this matter?

At some point in the future, you are going to use your net worth for income. It makes sense to protect our money from taxes as much as possible when our income becomes more limited in retirement. The tax triangle just gives you an idea of where you are. It allows you and your CERTIFIED FINANCIAL PLANNER™ practitioner to have an idea of what your future income is going to look like later in life. Look, we don’t know what taxes will do in the future. However, although I’m not a betting man, I have a feeling that Washington (in all their infinite wisdom) is not going to be getting rid of taxes, so working to minimize its sting is the goal. That’s just my personal opinion. Yours may differ and that’s fine. Whatever opinion, let’s at least try to make our lives Financially Simple.

Are you utilizing all three points of the tax triangle? If not, reach out to us. Our team can assess your current financial situation to develop a customized plan to help you grow your wealth.