Income-driven financial planning may help reduce taxes

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Income-driven financial planning may help reduce taxes

Expert Perspective


October 10, 2023

No one likes paying taxes, but the good news is that it’s possible to reduce taxable income through tax planning. Examining an investor’s tax returns from prior years can help identify financial planning techniques that may reduce their tax liability. Our experts break down what to look for and some techniques that can help investors realize immediate tax benefits.

For more insights on this topic, check out the first installment of our tax-planning framework series, Fundamentals of tax planning: Going beyond the basics.

Tax planning looks different for each investor as income sources, tax brackets, financial objectives, and other factors shape the investor’s approach. But tax planning can also be a starting point for determining what financial planning techniques may be appropriate for an investor’s portfolio.

Threshold planning

A fundamental element of tax planning is threshold planning. In a progressive tax system, tax rates increase with income. For example, Sam is a single taxpayer with an annual taxable income of $110,000. Based on the 2023 IRS income tax bracket guidelines, the first $11,000 of Sam’s taxable income is taxed at 10%, the next $33,725 at 12%, the next $50,650 at 22%, and the final $14,625 at 24%. 

A tax threshold is the last dollar of income in each income tax bracket. Upon earning an additional incremental dollar, the investor enters the next bracket at a higher tax rate. Accelerating or deferring income to remain in a targeted tax bracket supports the premise that each incremental dollar should be taxed at the lowest possible rate.


2023 federal tax brackets

A table shows how federal tax rates go up as annual taxable income increases for all tax filing types: single taxpayers, those married filing jointly, those married filing separately, and those filing as head of household. For 2023, tax rates start at 10% for up to $11,000 in taxable income for single filers and married filing separately, up to $22,000 for married filing jointly, and up to $15,700 for head of household.   Rates start at 12% for between $11,001 and $44,725 in taxable income for single taxpayers and married filing separately; between $22,001 and $89,450 for married filing jointly; and between $15,701 and $59,850 for head of household.  Rates start at 22% for between $44,726 and $95,375 in taxable income for single taxpayers and married filing separately; between $89,451 and $190,750 for married filing jointly; and between $59,851 and $95,350 for head of household.  Rates start at 24% for between $95,376 and $182,100 in taxable income for single taxpayers and married filing separately; between $190,751 and $364,200 for married filing jointly; and between $95,351 and $182,100 for head of household.  Rates start at 32% for between $182,101 and $231,250 in taxable income for single taxpayers and married filing separately; between $364,201 and $462,500 for married filing jointly; and between $182,101 and $231,250 for head of household.  Rates start at 35% for between $231,251 and $578,125 in taxable income for single taxpayers; between $462,501 and $693,750 for married filing jointly; between $231,251 and $346,875 in taxable income for married filing separately; and between $231,251 and $578,100 for head of household.  Tax rates cap at 37% for over $578,125 in taxable income for single filers, over $693,750 for married joint filing, over $346,875 for married filing separately, and over $578,100 for head of household.

Sources: Vanguard, based on Internal Revenue Service tax rate schedules for tax year 2023.

When planning around an investor’s tax thresholds, it’s best to take a long-term approach. Assess the structure of the investor’s portfolio, which may include account types such as an Individual Retirement Account (IRA), a 401(k) plan, or a health savings account (HSA). Depending on an investor’s goals and income outlook, it may make sense to incorporate tax-free income—such as Roth distributions and municipal bond income—to remain under the targeted threshold. It may also make sense to lower current taxable income by taking advantage of income deferrals into a 401(k) plan, a traditional IRA, or an HSA. Deferring income can mean lower taxes today and in the future when they eventually make withdrawals.

On the other hand, it may make sense to increase taxable income today as part of a threshold-planning strategy. Accelerating income in an investor’s earlier years—when income tax rates are likely lower—could significantly reduce taxes in the future, such as in a Roth conversion strategy.

For example, Daphne is a single taxpayer with an adjusted annual gross income of $140,000. She anticipates that her income will rise significantly over the next few years and wants to take advantage of her current circumstances to do some Roth conversions. In this situation, Daphne will accelerate income to the top of her current 24% marginal tax bracket. She can convert up to about $40,000 from her traditional IRA to a Roth this year without paying a higher tax rate.

“The process of evaluating an investor’s current income versus future expectations informs the degree and magnitude of income adjustments to target,” said Ashley Greene, a Vanguard wealth planning specialist and co-author of the new research paper Fundamentals of tax planning: Going beyond the basics. “The question then becomes how to adjust an investor’s taxable income.”

Capital gains and losses

Capital gains and losses offer a notable opportunity for such adjustments; proper management of these gains and losses can affect an investor’s net return and total tax liability.

Understanding the triggers of any taxable capital gains is a key starting point to determine what tax-planning strategies may be appropriate. For example, an investor who needs to draw from investment accounts to fund spending needs can direct proceeds from their annual rebalancing or mutual fund distributions to a cash account for future use rather than automatically reinvest the proceeds. This can help avoid additional transactions—and the taxes on them—in the future.

Also, “pay particular attention to short-term gains,” said Garrett Harbron, Vanguard’s head of global wealth planning methodology and coauthor of the research paper. Short-term gains “do not receive the preferential tax rates that long-term capital gains do, so steps should be taken to avoid them.”

Other capital gains takeaways to keep in mind:

  • Watch out for cost basis. The default cost basis treatment for a given transaction may not be optimal for the investor, as other available options might be more tax-efficient. Evaluating positions at the tax-lot level, while time-consuming, may reduce the investor’s current-year capital gains tax liability and provide hidden opportunities for tax-loss harvesting.
  • Take advantage of capital loss carryforwards. Ensure that capital losses are accounted for. They can be carried forward indefinitely, but you must use them when you have the opportunity or else they’re lost. An investor who has $10,000 in capital losses and $8,000 in capital gains needs to subtract the losses at tax-filing time; they are not subtracted automatically. If the losses aren’t subtracted, the IRS will consider them lost anyway. In other words, losses cannot be stockpiled for future use. Whether they’re used in a tax calculation or not, the IRS treats an investor as having used them.

Everyone wants to pay less in taxes. To achieve that, Greene said, “you have to look at it in the context of what you’re paying over a lifetime, because you might make sacrifices today so that, on the whole, you’re paying less in taxes,

“It’s still all coming out of your pocket, so if you can make adjustments today to lower tax totals in the future, you’re still lowering your overall taxes.”

Fundamentals of tax planning: Going beyond the basics

This research paper highlights common tax-saving opportunities.

Roth Conversion Calculator

Determine the break-even tax rate and make IRA conversions with your clients’ best interests in mind.


All investing is subject to risk, including the possible loss of the money you invest.

Neither Vanguard nor its financial advisors provide tax and/or legal advice. This information is general and educational in nature and should not be considered tax and/or legal advice. Any tax-related information discussed herein is based on tax laws, regulations, judicial opinions and other guidance that are complex and subject to change. Additional tax rules not discussed herein may also be applicable to your situation. Vanguard makes no warranties with regard to such information or the results obtained by its use, and disclaims any liability arising out of your use of, or any tax positions taken in reliance on, such information. We recommend you consult a tax and/or legal adviser about your individual situation.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

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