How the tax-return can become a powerful financial planning tool
May 04, 2021 — NEW YORK–(BUSINESS WIRE)–For some people, submitting their tax return to the IRS is a relief as they put the paperwork out of sight, and out of mind, until next year. Others recognize that tax time is the perfect time to plan for the future while all the documents are readily available.
In fact, half of American taxpayers (55 percent) have used the information collected and entered on their annual tax return to create or make changes to their financial plan, with a little more than a quarter (27 percent) doing so annually, according to research conducted by The Harris Poll on behalf of the American Institute of CPAs (AICPA) in the fourth quarter of 2020.
“As good as it may feel to have taxes behind you, the information that you’ve just gathered is an up-to-date roadmap of your financial life right in front of you,” said Gregory J. Anton, CPA, CGMA, chairman of the AICPA’s National CPA Financial Literacy Commission. “Don’t simply file and forget your tax return. Use it as a tool to help you in developing a plan that will put you on the path to reach your financial goals.”
Concerningly, the survey found that a quarter of American taxpayers (23 percent) do not have a financial plan. For those looking for guidance on how to use their own tax return to develop a well-rounded comprehensive financial plan, the AICPA’s National CPA Financial Literacy Commission recommends using your 2020 tax return as a starting point.
These five areas of a tax return are a good place to start:
1. Who counts on you for support?
Your filing status (married filing joint return, head of household, etc.) and the dependents you list on your tax return give you a current view of who is in your household for financial reasons– a spouse, children, perhaps a parent or other relative you’re helping out. Especially if there have been recent changes, such as birth or adoption of a child or a student graduating college and starting work, it’s worth considering whether your health insurance, life insurance, education planning, estate planning, etc., are up to date.
2. Is your withholding aligned with the taxes you owe?
There have been a number of changes to withholdings over the past couple years which is why it is concerning that 45 percent of tax-filing Americans have no idea when they last updated their withholding. Your tax return will show you how much was withheld from your pay during the year and whether you came close to the taxes you owed or missed the mark in either direction. If too much withholding brought you a big refund, you’ve made an interest-free loan to the government. Going forward, it might make sense to adjust your withholding downward to more closely line up with what you expect to owe, giving you and an opportunity to invest the money and earn a return or access it to meet emergencies over the course of the year.
On the other hand, if you owe a significant amount at tax time, consider increasing your withholding to avoid possible IRS interest charges and penalties that can put a dent in your savings. For Americans looking for help understanding Form W-4, and the impact of changing their payroll deductions, the AICPA has information at 360FinancialLiteracy.org/W4. Understanding the impact of withholding is especially important for those looking to plan and improve their financial situation.
3. Where is your money coming from?
Your tax return provides an overview of your sources of income, including wages, earnings from savings and investments, Social Security and other retirement plans, self-employment or side work, and even sources like lottery ticket winnings and jury duty pay, since nearly everything that comes in for most people is taxable. Considering how much of your income is recurring versus one-time or sporadic is a great first step in budgeting, or updating your budget. Understanding what you have to work with is key to mapping out the level of spending that fits your situation and leaves room for saving toward your long-term goals.
4. Where are you on the road to retirement?
Your tax return can give you good information on your progress toward a financially secure retirement and highlight some opportunities to enhance it. For example, you can see how tax-deductible contributions to an IRA or pre-tax 401(k) deductions reduced your taxable income and how you may be able to increase the contributions going forward, boosting tax savings and your retirement nest egg. It’s a good time to consider increasing your contribution, especially if you’re not taking advantage of the maximum employer match.
For those nearing retirement, it’s a good time to start thinking about how you’ll transition from health insurance at work to post-retirement insurance, including Medicare and its related options when you qualify. It’s also worthwhile to start exploring various strategies for commencing Social Security benefits. The good news is that Medicare and Social Security offer various options to fit a variety of situations, but you want to be sure the decisions you make give you the greatest benefits.
5. Are your itemized deductions in line with your goals?
While the majority of people take a standard deduction rather than itemizing, those who do itemize get a clear view of certain financial items, presenting an opportunity to consider significant changes in your financial situation. For example, if state and local taxes are taking a big bite of your income, it might pay to consider moving to a lower tax area as part of your retirement planning. High medical deductions may mean it’s time for a check-up on your health insurance. For charitable contributions, you can magnify your giving power by grouping them into years when you have enough deductions to itemize, rather than giving about the same amount every year.
At times like these, the right advise is essential. For tens of millions of Americans, including small business owners, COVID-19 made this an extremely complicated tax year, and getting the right advice can not only help you make sense of your current tax situation but also plan for future life goals as well.
American taxpayers include those who have filed income taxes in the last 3 years. This survey was conducted online within the United States between October 1-5, 2020 among 2028 adults (aged 18 and over) by The Harris Poll on behalf of AICPA. n=1,636 have filed income taxes in the past 3 years. For complete survey methodology, including weighting variables and subgroup sample sizes, please contact [email protected]
About the AICPA’s 360 Degrees of Financial Literacy Program
The AICPA’s 360 Degrees of Financial Literacy Program is a nation-wide, volunteer grass-roots effort to help Americans develop a better understanding of money management and take control of their financial lives. Since 2005, the AICPA has been empowering people to make better decisions with the tools and resources on the 360 Degrees of Financial Literacy website. Financial Literacy is the cause of the CPA profession and the 360 Degrees of Financial Literacy program is the AICPA’s flagship corporate social responsibility effort. These efforts are focused on financial education as a public service and are completely free from all advertising, sales, and promotions. Connect on Facebook for tips, insights and motivation to keep your finances on track.
About the American Institute of CPAs
The American Institute of CPAs (AICPA) is the world’s largest member association representing the CPA profession, with more than 431,000 members in the United States and worldwide, and a history of serving the public interest since 1887. AICPA members represent many areas of practice, including business and industry, public practice, government, education and consulting. The AICPA sets ethical standards for its members and U.S. auditing standards for private companies, nonprofit organizations, and federal, state and local governments. It develops and grades the Uniform CPA Examination, offers specialized credentials, builds the pipeline of future talent and drives professional competency development to advance the vitality, relevance and quality of the profession.