Taxable, tax free,

And tax deferred. All assets

Are one of these three.

“What’s out there?” Photo by Jonathan Howard

I don’t know how many different types of accounts exist in the US financial system.

There are the usual suspects like checking and savings accounts, CDs, Roth and Traditional IRAs, 401(k)s, stock option plans, life insurance, annuities, etc. On the asset side, you have cash, real estate, mutual funds, ETFs, stocks, bonds, and on and on.

The government regularly creates new instruments as well, like Qualified Opportunity Zone Funds. The list of tools available to the investing public is rarely the same from one year to the next.

It can all be overwhelming. Like floating in dark water, you don’t know what’s swimming around with you, or whether or not it might be dangerous.

Fortunately – you won’t read this often – the tax code is here to help. You can divide everything you have into one of three categories: taxable, tax deferred, and tax free.

That’s it.

Taxable accounts, like a savings account, are taxed this year. They will generate a 1099 at the end of the year for interest, dividends, and/or capital gains. Tax Deferred accounts, like Traditional IRAs, are taxed only when funds come out of them. Tax Free accounts are funded with money that has already been taxed. Once those funds go into Tax Free Land, they will never generate a tax bill ever again.

The above paragraph holds true as long as you follow the rules. Break them, and you may find a Tax Deferred account contribution or a Tax Free account distribution has suddenly become taxable, with potential penalties added to the bill for good measure. Following the rules is mission critical.

Where are these rules? In the tax code.

Every financial instrument or transaction exists because the tax code says it exists.

The tax code says what it is, what it does, who it’s for, and what it can cost. This is what matters, not the biased opinions of financial celebrities and definitely not what some alarmist with a web cam and a ring light said on YouTube or TikTok. Hopefully, like distilling all assets in the financial system down to three types, this helps makes your financial landscape a little less stressful and complicated.

But how does anybody have the time and expertise to research the ever-expanding tonnage of the tax code? To make matters worse, it changes nearly every year.

In fact, some of our favorite strategies – Roth Conversions, Qualified Charitable Distributions, the Qualified Business Income Deduction – aren’t yet of drinking age. If you think the tax code is a shape-shifting kraken, you’re not wrong.

If you’re approaching your finances from a “taxes first” mindset, approach your team of financial service professionals the same way. Work with people who demonstrate competence in tax planning. Ideally these people should have more to say about taxes than “I hate taxes.”

The tax code isn’t cutting corners with you, so don’t cut corners with it.